It’s no secret that the American culture has money problems, but more specifically – credit problems. Consider the following statistics: every three months, 250,000 new families enter into foreclosure, and the average family has $16,000 in credit card debt. One reason American’s poor relationship with credit may be that many states’ educational systems aren’t great at producing financially literate graduates. That’s why we created this guide – to empower parents with a helpful step by step process that will provide them the tools they need to ensure that their children develop a healthy relationship with credit, and understand financial literacy by the time they graduate.
While this guide is a great resource for everyone, it can be particularly useful for parents who don’t feel qualified to teach their children credit-related concepts – whether that feeling comes from personal struggles with debt, a lack of aptitude for grasping difficult financial concepts, or a simple lack of education on these subjects. Regardless of a parent’s relationship with credit, there’s a lot they can and should teach their children.
Just because children aren’t going to be directly interacting with personal credit or financial products until they graduate high school, doesn’t mean that parents have to wait until then to prepare for their child’s credit future. Young children can be helped to form sound financial habits, and as they get older, they can be educated about increasingly complex credit-related concepts.
This guide will help parents understand how to promote positive credit awareness and responsible financial habits throughout a child’s development. Important concepts and behaviors will be highlighted, and examples of activities and additional resources will be given to use in four critical stages of development.
The four stages of development used in this guide are:
Overall, this guide identifies four primary ways for parents to prepare for their children’s credit future:
The Keys to Financial Literacy: Habit Formation and Education
Research on Habit Formation
The first important concept to understand is that children learn the most from how their parents model financial behavior. This process starts at a very young age. In fact, studies show that children from 3-5 years old are already exhibiting the ability to understand how their actions influence future outcomes, and at age 7 are already developing habits.
The best way to help children form beneficial habits is to intentionally model key financial behaviors. For younger children, real life situations are the most effective way to teach them. For instance, parents can give their children $3 and allow them to decide which piece of fruit to buy at the grocery store, or help them to save money for a new bike they want, and then take them to the store and allow them to purchase it.
As students get older, it’s important that they begin to understand complex financial concepts (like compound interest and credit scores). While parents should take a primary role in this process, many schools do offer optional (or sometimes required) financial courses. These can be beneficial, as studies show that students that participate in personal finance and economic education programs in K-12 have higher credit scores as adults.
Preventing Identity Theft
The theft of children’s identity is more common than many people might believe. According to a study conducted in 2011, “10.2% of the children in the report had someone else using their Social Security number – 51 times higher than the 0.2% rate for adults in the same population.” Obviously, the best way to ensure that children don’t suffer from identity theft is for their parents to carefully guard their personal information, and teach their children to do the same.
Since there’s no way to absolutely guarantee that a child’s identity is entirely protected, verifying that the child hasn’t been a victim is a significant step to take when preparing for his or her credit future. Unfortunately, checking child’s credit report isn’t as easy as checking an adult’s, as it includes mailing documentation to the credit reporting agency that verifies the identity of the parent requesting the report.
Since most parents aren’t likely to put in the effort to check their children’s credit report annually, it’s important to understand the warning signs that occur when a child is targeted for identity theft. If there is cause for concern, parents should always check their child’s credit report as soon as possible. For younger children who’ve had no exposure to credit yet, no report should exist. If one does, it’s a sign that someone stole their identity. To repair the damage caused by identity theft, follow the steps recommended by the Federal Trade Commission.
Preschool and Early Elementary
At this age, children learn the best through hands-on activities, and lessons about money should include plenty of real-life experiences. Below is a list of important concepts for children to learn in this age-group, and activities to help the lessons sink in.
The Different Types of Money
Lessons that fall under this category include helping young children to understand that paper money, coins, and credit or debit cards are all different types of money, and helping them to learn about the value of certain types of currency. For instance, at this stage children are learning that a dollar bill is worth more than a dime, and a dime is more valuable than a nickel – even though a nickel is bigger than a dime.
Playing “store” with pretend money is an activity that can help children to understand the different values that specific types of money have. A more advanced lesson would be to simulate a debit card transaction – in this scenario, the child will give the adult an amount of money, and the adult will then put the money in “the bank,” and hand them a “debit card.” The child then buys an item, and the adult takes the corresponding money out of “the bank” and puts it away.
Other activities include allowing children to help count money for a parking meter or purchase at a store.
What Money is Used For
While parents should help their children to understand that money is used to buy items that a person wants or needs, teaching them that money is also used to help other people is important. When children see that money isn’t just about themselves, but about providing for others (including your family), it helps them to develop a healthy attitude towards finances.
One example of an activity that parents can do with their young child is for the parent to give their children $5 at home, and then take them to the store and allow them to hand the money to the cashier to purchase an item. Another great activity to do as a family is to give physical money to a charity or non-profit organization and explain what that money will be used for.
How to Get More Money
Young children tend to think that money is unlimited and comes out of nowhere – especially when a credit or debit card is involved. Parents need to underscore the idea that money is limited and you can’t buy everything you want.
By allowing their children to come to work with them (if appropriate), parents can help them understand that money must be earned. Parents can further teach this concept by paying their children to do small tasks like picking up pine cones or helping to wash a car.
The following resources provide more activities and additional educational material:
- The University of Minnesota: This is a resource that lists developmental characteristics of young children and suggested teaching activities for parents.
- The Federal Deposit Insurance Corporation: This is a downloadable lesson plan developed by the FDIC that is designed for children from K – 2nd grade.
- The Consumer Protection Financial Bureau: This agency has developed a resource dedicated to providing ideas and resources for parents of young children.
The earlier parents start helping their children to form healthy financial habits, the better. Habits that can be learned at this age can be broken into three basic categories: spending habits, saving habits, and sharing habits
In the early stages of development, this habit is just beginning to form. An important word to that children need to hear is “no.” Parents need to evaluate whether they are allowing their children to get the impression that money is used to buy anything and everything they want. An activity to help teach this lesson could be to make them choose between two small toys that they want at the store while explaining that you can’t buy everything you want.
This habit is especially important to start developing as early as possible since it doesn’t come naturally to most children. If parents can get their children used to the idea of saving a portion of their income from an early age, it can have positive effects throughout their entire lives.
While there will usually need to be some enforced saving (especially at first), there are ways to get children excited about the idea of saving. One possible way to encourage this habit is to give them one dollar and tell them that if they spend it, they won’t get any more, but if they save it until the next day, they will get another dollar. This activity also has the side-benefit of introducing a very basic form of interest.
As was briefly mentioned earlier, having a healthy attitude towards money should include the concept that money isn’t just for them, but it should also be used to help others. Giving a reasonable amount of money away can help to control reckless spending habits as well.
A rewarding activity to do as a family could be to encourage the child to take a portion of their money and use it to buy a gift for someone in need. For instance, the child could buy a small package of socks and give it to a homeless person.
The Three-Jar Method is a way to incorporate all three of the habits above into one system.
Here’s how this works: the parents collect three clear mason jars and write “save” on one, “spend” on another, and “share” on the last. Any time the children get money (birthday gifts, allowance, etc…) the parents divide it up into three parts and deposit it into the jars, then have their children use the funds accordingly.
The percentages that are deposited into each jar don’t really matter – whether it’s divided up with a ratio of 50/40/10 (spend/save/share) or 33/33/33, the children are still starting to form positive financial habits.
One habit to especially emphasize during this timeframe is saving. While it’s helpful to introduce this concept at a younger age, it should be reinforced as children continue to get older. The more excited parents can get their children about saving, the better. The following are ideas to help inspire children to save.
Open a Savings Account
Parents can help their children view saving in a positive light by making a big deal out of going to a local bank and opening a kid-friendly savings account. If parents are planning on giving out some form of allowance, a monthly trip to the bank to deposit the portion of the funds that is being saved is also a good way to help children make saving a habit.
Since children at this age are starting to want items that cost more money, it can be helpful to set up jars with pictures of items they want to save up for. For instance, a child might want to save up for a $20 Nerf gun, a $100 American Doll, and a $200 iPod. Parents can set up separate jars for each item and help their children to decide how to split up deposits. Seeing the money grow in the clear jars can really motivate them to save, and learning how to achieve savings goals is a valuable skill that will benefit them later in life.
To help drive their children to save for a more expensive item, parents can match savings contributions. While this helps children to get excited about saving, it can also teach a valuable lesson about the power of an employer-matching program for a 401k.
Children in this age-group are learning how to make spending decisions. Since there’s a lot more that goes into good spending habits than just self-control, it’s wise to take a more comprehensive approach. There’s a list below of several fundamental aspects of spending to address.
There’s more to price comparison than just teaching children how to buy the cheapest item in a grocery aisle – quality and quantity should also be taken into account. The general idea is that sometimes it pays to buy a more expensive item because of it’s higher quality or larger quantity. Parents can begin to teach children how to read labels and figure out the price-per-unit to accurately compare pricing between products. The Consumer Financial Protection Bureau has some helpful tips for parents who want to utilize price comparison as a teaching tool.
An example of an activity to help children learn about price comparison is for parents to ask their children to compare rolls of toilet paper – a child’s first thought might be to pick the cheapest package. Parents can help them learn this valuable lesson by explaining why a different package is actually a better “deal.” Another option would be to allow the child to purchase a low-quality package of toilet paper, and discuss why it was a bad or good choice after sampling the product at home.
Sales and Coupons
Another way to help children build good spending habits is to teach them how to take advantage of coupons and sales. For instance, parents can explain to their children why they are buying three jars of spaghetti sauce instead of just the one that they need (the sauce is on sale and would need to be purchased later anyways).
Parents can help children understand the value of coupons by allowing them to look over the grocery list and clip appropriate coupons before the shopping trip. Parents can then give the child the money they saved from using the clipped coupons.
At this age, children usually have a very hard time controlling their desire to shop compulsively. Obviously, it’s important to help them control these urges and explain that they might not want the item as badly after they leave the store. One way to reinforce this lesson would be to allow the child to buy an item with his or her own money that the parent knows they won’t want when they get home, and then discuss without judgment what was learned and the consequences of compulsive shopping.
Learning how to be fiscally responsible is usually a process that requires a commitment to learning from mistakes. It’s far better to learn from mistakes when the amount of money being wasted or misused is $10 rather than $1,000. While allowing children to waste their money however they want isn’t helpful, allowing them to be responsible for their own money helps them learn valuable lessons during this stage of development. Giving children an allowance is the most common way to allow for a small amount of responsibility, but there are several other ways for them to learn as well.
A Traditional Allowance
70% of children are currently receiving an allowance, but parents are making an effort not to let their children view it as “free money.” Deciding to give children an allowance is a personal decision for parents – if parents do decide to go that direction, the allowance should be used as tool to help them learn responsibility and other good habits. While using actual jars may or may not still be practical for children at this age, the Three-Jar Method that was explained earlier can be good way to use a child’s allowance as a tool to teach them fiscal responsibility.
Earnings from Extra Chores
An idea that’s picking up steam with parents is the practice of paying children money if they do extra chores – this could either be instead of, or in addition to, an allowance. The key here is that parents should only reward extra chores. For instance, vacuuming out the car gets $5, while taking out the trash is expected and gets $0.
This tactic takes careful planning and execution, but it’s a potentially great way to teach children how to be responsible with money.
Here’s an example of how this could work: a parent gives a child a certain amount of money for food and souvenirs on a family trip. The parent would explain how much money can be spent for each meal, and how much is budgeted for souvenirs. The deal is that if the child overspends at the beginning of the trip and runs out of money for food at the end, then the parent will cover the cost of the food, but the child won’t get dessert or soda and will be required to pay back the money or work off the debt.
Parents that want additional ideas for teaching their elementary children about finances can refer to the following resources:
- The University of Minnesota: This study lists money-related behaviors to expect and practical activities for children during this developmental stage.
- The Federal Deposit Insurance Corporation: This is a series free downloadable lessons plans for children in the third thru fifth grades.
- Consumer Financial Protection Agency: A brief Q&A that lists helpful activities to teach a few key concepts
Middle School and Jr. High
Middle school is the perfect time to start learning about credit related concepts. While they might not be able to fully grasp all the complexities, they can start understanding how credit works.
This concept is a hard one – even for some adults, so parents may need a little help in explaining it accurately. Thankfully there are a couple of great resources that parents can utilize. The first is a lesson plan developed by the Education Investor Foundation, and the second is a list of three ways to illustrate compound interest that’s offered by the Consumer Financial Protection Bureau.
A way for parents to encourage their children to learn about the power of compounding interest would be to help them start saving for a large, long-term goal like their first car. The parents then pay them monthly compounding interest at a high rate on the savings. This strategy comes with several side benefits. First, the parent would be contributing to the child’s savings in a meaningful way that would help them save up a lot more by the time they were ready to get the car. Second, it would encourage the child to save more and continue to form good saving habits. This compounding interest calculator can help parents with the calculations.
An honest discussion of a parent’s personal experience with debt can be very helpful in educating children about the dangers of debt, and when it makes sense to use credit rather than saving up for a purchase. For example, a parent could relate a story of how they ran up a significant amount of credit card debt in college and how that impacted them for years afterwards.
An excellent activity to help children get hands-on experience with debt at this age, is to loan them money for something they want, and then charge a high interest rate (similar to a credit card) while requiring a monthly payment. This type of activity can help to illustrate the cost of borrowing money.
This is a good time for parents to explain what an Annual Percentage Rate (APR) is. Also, older pre-teens may be interested in learning about the difference between a fixed APR and a variable APR.
The Difference Between Credit and Debit Cards
Understanding the difference between credit and debit cards is a good first step to learning about credit cards. The major lesson to be learned here is that debit cards are simply a way of using your own money that’s in your bank account, while credit cards are an easy way to borrow money that needs to be paid back later.
Parents can help to drive this point home by showing their children their bank accounts online, and how a credit card charge adds debt, while a transaction made with a debit card withdraws funds. To help them further understand how to use debit cards, parents can give them a retail gift card with a small balance and show them how to track how much money is on the card online. Another idea is to load an allowance (or funds earned another way) onto a pre-paid debit card. This will allow pre-teens to get in the habit of tracking expenses online, and give parents an opportunity to review spending habits with their children.
By this point, pre-teens should understand that you can’t spend more money than you don’t have (unless you borrow money, of course), but they might not understand the concept that you don’t just spend your money on whatever you want until it runs out. Now is the time to help them to start getting into the habit of budgeting.
Parents can help their children to learn the concept of allocating funds in several ways. First, they can create a simplified version of their personal budget and allow their children to access it and discuss how the family’s income is spent. Of course, this means that parents need to get in the habit of budgeting as well, but they don’t need to be perfect. Being honest with children about what is working and what is an opportunity for improvement, is a good way to help them learn – at this age, children are already aware that their parents aren’t perfect, so admitting faults isn’t always a bad thing.
The second way for parents to help their children learn about fund allocation is to help them create a simple budget for themselves. The more the students take control of this process, the more likely they will be to follow through. Since pre-teens who work odd jobs don’t usually have the same income every month, parents can help them create a budget that’s based on percentages rather than dollar amounts. A sample budget is shown below.
Timely Bill Payment
A critical part of developing solid budgeting habits, is learning how to set up a system for paying bills on time. There’s a lot of different methods out there. Some people use a calendar that shows the bills’ amounts and the date that they are due. Others use a whiteboard to create a checklist with due dates for the whole family to see. A spreadsheet can also be utilized in a similar way.
Parents can get their students used to this idea by including them in the process and explaining which bills they pay when, and how they track due dates and amounts. During this activity, it could also be helpful to show children which bills have a “grace period” and which immediately charge a late fee. Discussing the amounts of late fees can also reinforce how important paying bills on time is.
Since children are exposed to the internet and technology at an increasingly younger age, the risk of identity theft for middle schoolers is growing. Financially speaking, this presents two types of danger: identity theft and scams.
Data Hygiene is the practice of protecting your personal information, and it’s an important concept to teach children at this age. Children might not have the experience that warns them not to enter their personal information on a site that claims to be giving away a free iPad. Parents should consider discussing the proper use of personal information across the following categories:
- Social Media: Home addresses, phone numbers, and full birth dates shouldn’t be shared on social media.
- Online Giveaways: Students should be especially careful about online giveaways – never enter personal information, especially payment information, on sites that are giving away some product or service for free.
- Online Pop-ups: As a general rule, “pop-up ads” shouldn’t be clicked, and students should never give any information if it’s requested.
- Shared Computers: Whether at school or a friends house, students should be careful about logging into sites with sensitive information (like online banking websites) or entering personal information.
The Consumer Financial Protection Bureau lists a couple of ways for parents to talk to their children about protecting personal information.
Parents should consider the danger of scams – not only to a child’s personal safety, but also to their finances. The more access children have to bank accounts and debit cards, the more susceptible they will be to potential scams. Performing a case-study on a real scam could be a valuable activity which can help to educate children, as well as reinforce why utilizing common sense is so important.
The Investor Education Foundation developed a game to educate children about financial fraud called “Con ‘Em if You Can.” Additionally, the Federal Trade Commission has a site that lists new and common scams.
Helping high school students to have a good grasp of personal finances is a great way to prepare them for the real world and the challenges of developing robust credit. While the introduction to personal finances can start in middle school, high schoolers should definitely have a firm grasp on the basics, like budgeting and banking, before graduation.
By the time a high school student has a regular job, parents should be teaching them how to budget, and encouraging them to do so. As the saying goes, if you don’t have a budget, you aren’t controlling your money – your money is controlling you. If high school students develop the habit of budgeting, it will save them a lot of trouble down the road.
Even parents who aren’t great at budgeting themselves can help their children to learn this valuable skill. Below is a list of resources for parents to use:
- Oklahoma Money Matters: This article provides some basic guidelines for setting up a budget and links to budgeting tools.
- Oklahoma Money Matters: This PDF gives a sample budget and three easy steps to starting a budget.
- Toshl.com: This is a website and app that lets users create a budget and enter expenses. Its simple interface allows it to be used by older high school students.
Another important aspect of personal finances that high schoolers need to get a handle on is banking – especially how to manage a checking account with online banking. When students get their first real job, they will usually need to set up a checking account since most employers utilize direct deposit. Parents should direct students to a bank that has free checking accounts for students, easy-to-use mobile apps, and quality online tools.
When students get their first debit card, parents can use that as an opportunity to discuss how and when to give out their debit card number. Online purchasing is an especially important topic to cover.
While there may be high school courses that teach some credit-related concepts, it’s always a good idea for parents to personally make sure their children know the basics about topics such as credit scores and credit cards.
Since credit scores have a much larger impact on a student’s future than they typically realize, it’s important to help them to understand the benefits of having a high score, and what happens if your credit tanks. For instance, parents can explain how some employers don’t hire employees with extremely poor credit, and a low credit score can also mean that they might have to settle for a car payment with a high interest rate – which means more money out of their pocket every month.
According to the Consumer Financial Protection Bureau, “A credit score predicts how likely you are to pay back a loan on time. A scoring model uses information from your credit report to create a credit score.” A credit score differs from a credit report, in that a credit score is a single number that sums up your credit history, while a credit report breaks down that history in detail.
When lenders are evaluating borrowers, they look at a person’s credit report and credit score to determine how likely that person will be to repay that loan on time. Those with poor credit are a higher risk, which means that the lender will either deny the loan, or charge a higher interest rate.
There are four main things that lenders look for:
- On-Time Payments: Lenders prefer borrowers who have a long-established history of making loan and credit card payments on time. They take a hard look at those with missed payments, or a short history of payments made (less than a year).
- Credit Utilization: What’s the ratio of a person’s available credit to the amount of credit that is currently being used? If a person has high credit utilization (meaning that they have very little unused credit), then lenders tend to charge a higher interest rate or deny the application for credit.
- Inquiries: Whenever someone applies for credit, a credit report is pulled which counts as an “inquiry.” Lenders tend to penalize those that have had too many inquiries in a short period of time.
- Credit Lines: How many different lines of credit does a person have, and how many different types? If there a large number of the same type of credit cards or open loans, it could hurt that person’s chances to get approved with a low interest rate.
For more information on credit scores and credit reports, you can read this guide developed by the Federal Trade Commission.
Open-ended credit (also referred to as revolving credit) can be used over and over, as long as the limit isn’t reached. The full balance doesn’t have to be paid off, as long as monthly payments are being made. Although lines of credit, like Home Equity Lines of Credit (HELOC), are technically considered open-end credit, credit cards are the most common type.
Although high school students won’t be able to get a credit card in their name until they turn 18 (or in some cases 21), it’s important for them to learn the basics and clear up any misconceptions they might have.
For starters, high school students should know that there are different types of credit cards:
- Rewards Credit Cards: This is a “normal” credit card. The interest rate is dependent on the credit score of the cardholder. When the card is used, a reward is earned which could take the form of airline miles, cash-back, and more.
- Store Credit Cards: This type of card is basically a line of credit that a store extends to a customer to encourage them to spend more at that business. Store credit cards usually come with discounts and other rewards, but often have higher interest rates than traditional credit cards. Some cards are also sponsored by a major credit card brand like “Visa.” Those cards can be used anywhere, but carry additional rewards at the original store.
- Secured Credit Cards: A secured credit card requires a refundable security deposit which allows the credit card company to extend credit to those with poor credit. However, the interest rates and fees are usually quite high. They can be used to help repair a person’s credit.
- Student Credit Cards: These cards are usually marketed to college students and don’t require an extensive credit history. Student credit cards usually include a relatively high interest rate and hefty fees.
Parent’s can help their high school students to better understand credit cards by adding them as an authorized user on their account. However, there are definite risks and drawbacks to this approach – the specifics are discussed below.
Closed-ended loans (also called installment loans) are given to a borrower for a specific purpose and a specific period of time. This type of credit is paid back in installments until the original amount of the loan is repaid.
When a student turns 18, they will likely start getting letters in the mail advertising things like “$5,000 cash NOW!”. Since there are so many lenders out there that would love to take advantage of an inexperienced young adult, parents can ensure that their children are prepared to steer clear of potentially harmful loans by explaining the advantages and drawbacks of different types of loans.
The following is a brief overview of a few of the common types of closed-end credit:
- Mortgages: A mortgage is a loan given to a consumer to buy a home. Mortgage terms (the length of the loan) can range from 10 – 40 years. They may or may not require a down payment.
- Auto Loans: There are different ways to get an auto loan. For instance, borrowers can approach a bank or credit union and get a loan, or get a loan directly from the car dealership. Loans secured through a bank or credit union usually come with a lower interest rate, while dealerships tend to be more willing to give loans to borrowers with poor credit.
- Student Loans: Student loans are used to pay for college, and can be private or federally funded. Federally funded student loans are usually preferable as they tend to offer lower interest rates, and may even be subsidized (the interest of the loan is paid by the government while the student is in college). Additionally, federal student loans may be eligible for repayment plans that can forgive a portion of the loan.
- Payday Loans: Payday loans are secured loans, which means that they use a borrower’s upcoming paycheck as security for the loan. These types of loans usually have ultra-high interest rates – for example, a typical 2-week payday loan could charge $15 for a $100 loan, which equates to an Annual Percentage Rate (APR) of 400%. To put that in perspective, typical credit cards come with APRs of around 12% – 30%. For more information on Payday loans, read the guide provided by the Consumer Financial Protection Bureau.
It’s important to lay the groundwork for how to use credit properly before children get their hands on their first credit card. Obviously, that could end poorly if they aren’t adequately prepared. Students should have a good grasp on the importance of making payments on time, and how and when to use credit. Parents can help their children – not only by explaining the proper usage of credit, but also by relating personal or family stories of good and bad experiences with credit.
In order to be prepared to use credit when the time comes, high schoolers should know the consequences of missing payments, and what happens if you run up a large balance and make only the minimum payment on a credit card.
It could be helpful for parents to explain a recent credit card statement to their students – especially the section that lists how much money would be paid and how long it would take if only the minimum payment were made. Another important aspect to point out is the late fee – how much is it, and is there a grace period or is it charged immediately?
The Federal Trade Commission created a video that can help to illustrate to high schoolers what happens when only the minimum payment is made. Another way to help drive this concept home, is for a parent to loan their high schooler money and create a repayment agreement that requires payments to be made, charges a high interest rate, and penalizes late payments with a $10 – $20 late payment fee.
Credit Usage Guidelines
Since there are many of different schools of thought on how to use credit cards and other forms of credit, it’s important for parents to consider how they want their teenagers to use credit when the time comes. The first question for parents to ask is, “Do I want my teenagers to use credit the same way that I do?” Whether the answer to that question is yes or no, parents should know that unless there is intentional instruction and discussion about how to properly use it, it’s likely that students will pick up bad habits – whether from their parents or elsewhere. Parents can also utilize their own lapses of judgment to help their children learn from someone else’s mistakes.
While there’s plenty of pitfalls to avoid with credit in general, credit cards tend to get young adults in the most trouble. The following is a few common ways that credit cards are used (both good and bad):
- When You Just Don’t Have the Money: Whether out of impatience or need, many people use credit cards to buy things that they don’t have the money for. If a person is living paycheck-to-paycheck (they don’t carry a significant balance in their checking account), then credit cards are sometimes used as a payday loan. They will have the money to pay for the items, but they can’t (or don’t want to) wait until their next paycheck to make the purchase.
- As an Emergency Fund: While many experts suggest saving up an emergency fund, some people rely on credit cards to pay for unexpected expenses when they are in a pinch. Another way people use them is to carry a credit card on trips where unexpected expenses could arise.
- To Take Advantage of Rewards: Some people use credit cards like they would a debit card – meaning that they only buy things on their credit card that they would have bought on a debit card. They have the funds in their bank account, and they pay off the entire balance every month. This tactic avoids interest and takes advantage of the different types of rewards that credit cards offer, like airline miles or discounts on items purchased with a store credit card. If a large balance is carried, then the interest charged negates any gain from rewards earned.
- To Build Credit: Credit cards can be an effective way to build credit, but only if the credit card usage is responsible – no late payments are made, and the credit limit isn’t maxed out.
The more controlled exposure parents can give their high school students to the world of credit cards before they graduate, the better. Getting them a debit card attached to their own checking account can be a helpful practice to start building proper spending habits.
Establishing Credit Before Graduation
Children can’t get a credit card in their name until 18 at the earliest, and in most cases, they can’t until they are 21 (they may be able to get a credit card before 21 if they can prove that they have sufficient income to reliably make monthly payments). That being said, there are ways to help minors build a credit history while still in high school. Building up a positive credit history while under a parent’s direction and authority can give them a credit-jumpstart, or at least help to mitigate lapses of judgment down the road.
One way for parents to help their teenagers build credit is to add them as an authorized user on their credit card account. Of course, there’s plenty of risks to this approach. The following chart lists some pros and cons:
Adding Teens as Authorized Users
While there are considerable risks, adding teenagers as authorized users is definitely a valid option to consider. Parents who are thinking about going that route should consider putting some or all of the following guidelines in place:
- Don’t Use a Primary Account: Parent’s should opt to open a new account with a low spending limit, especially if their primary account has a high limit.
- Create a Usage Agreement: Create a specific set of written guidelines for how the credit card can be used, and how much can be charged. Optionally, parents can include payment due dates with late fees (payable to the parent) to simulate how credit card payments work.
- Use an Account with a Clean History: While parents can use a pre-existing account, make sure it’s not one with a history of delinquency, as that can reflect on the child’s credit report. If the parents aren’t 100% certain that they will be able to make the payments on time every month, adding their children as an authorized user could hurt their credit future more than it helps.
Best Cards for Authorized Users
The best type of credit card to open for parents who are adding their children as authorized users is a secured credit card. A secured credit card requires a deposit that the credit card company can take if the monthly payments aren’t made. The benefit of secured cards for adding authorized users, is that the credit limit is usually very low, which minimizes the risk for parents. This guide lists the best secured credit cards for 2017.
This tactic is especially useful if a student’s parents are planning on buying (or helping to buy) him or her a car. Instead of paying cash for the car, the parents can cosign a loan, with the option for the student to agree to refinance the loan in his or her own name at 18 years of age. This will help to establish a credit history, but the parents will be responsible, and their credit will suffer if the payments aren’t made. Of course, the cost of the loan should be considered as well.
There are many factors to think about, but the bottom line is that this is a potential way to build credit history for students. However, parents need to be aware that this could lead to problems down the road, and it’s not a great solution across the board – it depends on each person’s unique situation. For instance, if parents are expecting their children to help pay for the car, they need to consider whether they could afford to make the student’s portion of the car payment if the student can’t. Also, a car payment that is affordable for a student while living at home, may not be affordable after they leave home and are attending college or paying rent and other bills.
When the time comes for students to get their first credit card, there’s a whole lot to consider. If their parents have adequately prepared them, and even helped them to build a small amount of credit history, then they will have a huge advantage over many of their peers in navigating the complex world of credit. This guide to getting your first credit card has recommendations for which card to choose when the time comes.
Educational Resources for Teachers and Parents
- The Federal Trade Commission: Money & Credit
This is a great resource for families to learn more about money and credit. However, it’s not specifically designed for children.
- The University of Minnesota: Teaching Children Money Habits for Life
This is a resource that provides a helpful checklist for parents as well as a breakdown of how children can learn money habits in different developmental stages.
- The University of Minnesota: Teaching Children Money Habits for Life
This is a resource that provides a helpful checklist for parents as well as a breakdown of how children can learn money habits in different developmental stages.
- Financial Literacy & Education Commission: Resources for Youth
MyMoney.gov provides games, fun activities, websites, video games, and information about money for kids and youth.
- Consumer Financial Protection Bureau: Families and Money
This is a list of Q&A’s that are helpful for families that have specific questions about how to teach their children about finances.
- The American Bankers Association: Get Smart About Credit
“A national campaign of volunteer bankers who work with young people to raise awareness about the importance of using credit wisely.”
- The Federal Deposit Insurance Corporation: Money Smart for Young People
This is a curriculum that is separated into four different grade levels and is designed to teach students important financial concepts. It includes real-life exercises and examples.
- Investor Education Foundation: SaveAndInvest.org
This resource is especially useful for middle and high school aged students. Not only does it provide some great lesson plans, but it also has two video games designed to teach financial concepts, and multiple videos designed to build interest in finances.