Credit cards are a go-to payment method for many Americans, offering an easy way to pay for large purchases. However, this same ease of use can disconnect purchases from the cash needed to pay for them and can be especially confusing to teenagers, leading to harmful spending habits if they don’t learn the facts of credit cards. A 2012 survey by ING Direct and Capital One found that one quarter of teens age 12–17 don’t know the difference between a credit and a debit card. After all, purchases are made in much the same way, and concepts like interest and overdraft fees can be lost on many teens if they’re never taught how to manage them. Don’t risk your teen becoming fiscally ignorant—learn the steps you can take to prepare him or her for a credit card and responsible credit habits.
Practice makes perfect
The CARD Act of 2009 has helped to prevent credit card companies from targeting college students with prizes and pre-approved offers as well as requiring those under 21 to have proof of income or a cosigner to gain access to credit, helping to limit teens from damaging their credit score early on. However, even a part-time job can qualify teens for a card, and college still offers many new spending opportunities, which can cause teens to get in over their heads quickly with credit.
By teaching your children about the risks that come with credit card debt and allowing them to practice paying off the balance of a credit card before they’re out on their own, you can help them build a better credit score and become more financially responsible.
Talking about credit
The first step to helping teens handle credit is educating them about what credit is and how it works. Broaching the subject about credit can be difficult—the ING Direct survey also found that while 35 percent of parents are prepared to talk to teens about drugs and alcohol, only 26 percent are ready to talk about money. Consider the following tips for what to cover when you talk about credit and how to approach this difficult topic.
Cover the basics.
While some credit card concepts like compound interest, minimum payments, limits, etc. may seem like no-brainers to you now, remember that you too had to be taught these concepts. Explain that credit functions like a loan and that your teen will be expected to pay it back in full, plus interest, at some point.
Beyond understanding what credit is, understanding how the credit card process works is also important. Small details, like explaining that payments will take a few days to process and may be considered late if submitted on the due date, are crucial to helping your teen maintain good credit.
Also explain how interest rates and compound interest work, and how quickly debt can build up if the full balance isn’t paid each month. Showing how long it will take to pay off a balance if only minimum monthly payments are made can help stress that credit is a long-term commitment.
Discuss the good with the bad.
While credit can seem overwhelming at first, it’s important to stress how credit cards can be a useful tool when used correctly. Because credit cards help establish a credit history, timely payments lead to better interest rates, easier loan approval and even better prices on insurance premiums or utility services. Credit is also a good way to securely buy things online or to pay for large purchases.
Teens should be aware that people can use their credit card information against them and should know how to check their credit report, protect their credit information, check for fraud and report a card lost or stolen. You should stress the importance of getting a free annual credit report, available at www.annualcreditreport.com.
Lead by example.
Attitudes toward finance can be learned from a very young age, so the most important thing you can do is to set a good financial example. If you’re responsible with your own money and model positive behavior to your children from a young age, they will most likely follow suit. If you have credit mistakes in your past, be sure to explain what the consequences were and how you dealt with them.
Testing the waters
Before opening a credit card account for your teen, first evaluate if he or she is ready for a card. By taking the following small steps, you can help your teen build financial responsibility.
If your teen doesn’t have a checking account or access to a debit card yet, this can be a good way to help establish the link between a plastic card and real money, as funds will be automatically withdrawn from the account when the card is swiped.
Review debit card statements with your teen each month and set an amount for how much he or she can spend. And be on the lookout for the following warning signs, which likely signal your teen may be struggling with manging money: overspending, consistently overdrawing an account or expecting someone else to pay for purchases when he or she can’t.
If your teen masters using a debit card responsibly, consider exploring credit card options.
A secured credit card is much like a debit card. Funds are tied to the account rather than a line of credit, but your teen will still be responsible for making payments, and you can have his or her lender report activity to a lending bureau to help establish credit. This helps curb overspending and promotes the habit of paying off a credit card bill each month.
Adding your child as an authorized user or cosigning for a credit card will likely be the last step you take before he or she can begin using a card.
As an authorized user on your account, your teen gets a card with his or her name on the front, although you will be responsible for paying the balance each month. However, this allows you to monitor your teen’s spending and help your teen build credit. By cosigning for a card, you both will be jointly liable to repay the debt, so it can be more difficult to close this type of account should spending get out of control. Opt for a card with a small limit and make sure the bill is paid in full each month. Again, jointly review your monthly statement to show how spending directly affects the bill.
Is your teen ready for a credit card?
If your teen demonstrates responsibility using a debit or credit card, it’s a positive sign he or she is on the way to building a strong credit foundation. While you can’t control what your child chooses to spend his or her money on, simply talking about how to manage credit and tracking spending during the teens years goes a long way in helping to build a strong credit foundation once your child strikes out on his or her own.