Podcast #40 - Establishing Good Credit for Your Children and Some Important Reminders for Adults
-Factors needed to generate a credit score
-What is a authorized user and cosigner on a credit card
-How young adults can obtain their own credit card
-What are the credit score ranges from the three major credit bureaus
-Good budgeting habits to handle the responsibiltiy of owning a credit card
This week’s topic is about building credit for your children while reviewing some tips and reminders for the parent’s credit situation as well.
First off, it is one thing to have credit; however, it is another to have a good credit score and when you achieve this, it simply means that you will be offered the most optimal interests to borrow money.
Now in case you didn’t know, not everyone has a credit score.
If you have no credit accounts or have opened accounts with lenders that do not report the payment status to a credit reporting company, you probably will not have much of a credit report.
However, keep in mind, You can have a credit score without a credit card if you’ve taken out a loan, had rent payments reported to the major credit bureaus or fallen behind on other items like your utility bills.
-A credit score is just a way of summarizing the contents of your credit reports.
-In addition to any credit card accounts you’ve had in the past seven years, credit reports contain information about other loans and lines of credit you’ve had and if you’ve been sent to collections or sued for amounts owed.
So even without using a credit card, you still could have a credit score if you’ve otherwise borrowed money or failed to pay some key bills.
Unpaid alimony and child support also are noted on credit reports as well as tax liens.
So let’s get into the basics; as much as we are not proponents of having debt on credit cards, they can be a very important budgeting tool to manage money as most purchases and services are paid for on a monthly basis. In addition, they offer theft protection for the purchases that you make.
So with reference to having credit cards, Cindy and I charge 95% of the purchases that we make and we pay them off each month. This is the path that everyone should be looking to achieve. We simply link our credit account to our bank account with an auto payment each month. This method should keep you from overspending, as you really should pay off what you charge each month.
So when it comes to the children . . . they’re going to be out in the world one day and when they start to buy things, having a good credit score is extremely important. I worked with a colleague who was 26 and didn’t have a credit card. She had no credit history other than a car she was driving, with her mom as a co-signer. I actually steered her into getting a credit card to start building credit. She admitted that her parents had never given her any direction on this subject.
So this is a great example of the importance of building credit, because as adults, we know it provides the ability to buy many things, especially items that are too costly to buy with cash, like a house or a car, furniture, a boat or even getting a business loan.
On a smaller scale, people can buy just about anything, down to smaller size amounts with places such as PayPal which apply more to the children.
So that brings us to the question: How do we establish credit for your children? You cannot apply for a credit card legally until you turn 18. In some cases, you can be under 18 as an authorized signer on your parents.
The good thing is that becoming an authorized user does help a credit score to a degree; however, it is not as robust as being a primary cold holder.
Now with that being said, when you do turn 18 and you don’t have solid income, then this is a situation where the parent may need to cosign on the card.
Okay so let’s cover the responsibilities that come with your children having credit cards.
1) If your child is working then he or she may not need a co-sign on the card; however, if you are a cosigner then remember that you'll be on the hook for paying the card off if your child doesn't. This is logical as the child will not not be responsible for any of the bills. As an FYI this can apply as well when a parent is a cosigner on a car.
2) The second thing is that it is important that your child is ready for the responsibility to manage a credit card. Therefore, teaching some basic budget skills is very important.
I know that when our children started working, they began to show more responsibility with their money because it was theirs and in fact, they stopped asking for money from us, and started being much more careful about how they spent their money!
Now that sounds great but that doesn't mean the kids are going to pay the card off in full and that is why we mentioned budgeting is very important; however, a good way to ensure that they do not just simply start blowing money without their oversight is to put a very small credit limit on the card and that way once they hit the threshold, they can no longer charge at until their balance is below the limit.
So why don’t we go over some items for your young adult to build good a credit score:
David Secured Credit Card
A secured credit card is backed by a cash deposit you make when you open the account. The deposit is usually equal to your credit limit, so if you deposit $200, you'll have a $200 limit.
Credit Builder Loans
They also go by names such as "Fresh Start Loans" or "Starting Over Loans." They are not widely known and they are usually offered by smaller financial institutions.
With this loan, the money that you borrow is held in a bank account while the payments are made. In most cases you can’t access the money until the loan is fully repaid. The goal is to have good discipline to build savings and credit at the same time and protect the lender’s risk position. The good thing is that when the payments are made they are reported to at least one credit bureau.
So let’s discuss what is a good credit score.
According to Equifax, the ranges vary depending on the credit scoring model; however, generally credit scores from 580 to 669 are considered fair; 670 to 739 are considered good; 740 to 799 are considered very good; and 800 and up are considered excellent.
When our kids all hit 18, they applied for the Discover card for students. We basically had them buying gas and small grocery purchases, and had them link to their bank accounts to pay it off. As a result, Justin has built up his credit score in the high 700’s, and was able to buy a car on his own at age 23 with low interest. He also rented an apartment without a cosigner, and he obtained a furniture store card with a zero interest loan known as deferred interest to buy his first couch.
That was a very good topics so now it’s time to do the recap:
As soon as your child turns 18, they can apply for a credit card. Explain to them the importance of starting a good credit history so in the future they can get the best rates in case they need to borrow money. This can provide advantages to borrowing for on things like:
1. Significant Savings on Interest Rates on Big-Ticket Loans
2. Better Terms and Availability on Loan Products
3. Access to the Best Credit Cards
4. Insurance Discounts
5. More Housing Options When Obtaining Mortgages
6. Security Deposit Waivers on Utilities
Teach your child good budgeting habits: Provide information on how to balance a budget and a checkbook. Show them how to set up auto pay linked to their bank account, and only use their credit card for small purchases to buy and pay it off.
When our kids turned 18 they would use the credit card for gas and groceries, and we’d keep it at home and out of their wallets to curb any urge to use it for purchases they could not afford to make.
Cindy and David #3
What are some of the things that you can teach your child to do to Improve their credit scores?
limit the Number of accounts: Credit scoring models also look at how many credit accounts you have open and on how many you carry balances. It's better to have more accounts that don't have a balance than ones on which you do carry a balance.
Don’t apply too many times to have hard inquiries:
When you apply for a new credit card or another kind of loan, the lender will request your credit report. That is known as a hard inquiry and will lower your score slightly. Monitor your Negative credit information
Monitor your credit report to ensure that there is no negative financial information, such as bankruptcy or collections on the account.
Pay on time
This is typically one of the most important factors, around 35% in determining your score in many scoring models. Obviously, missed and late payments will bring your credit score down.
By paying your credit card off every month, the credit reporting agencies will report consistent card activity and this means you will not have revolving debt and this should give you a favorable score.
Look on the Internet for sites like WalletHub, NerdWallet, or Credit Karma. Based on your credit score, Credit Karma will suggest cards that you will most likely get approved for.