It can be difficult to teach your children about budgeting, financial responsibility and the value of good credit. How should you go about it? Is giving an allowance the best way to start? Should they figure it out on their own? There is no right answer. But one thing is clear: It's essential for children to learn these concepts.
There are countless news stories of younger generations being buried in debt with no glimmer of hope. According to a recent survey by the Pew Research Center, only 24% of young adults under the age of 22 are financially independent. However, in that same survey, 64% of parents indicate that young adults should be financially independent by age 22 or younger. This discrepancy shows that money isn’t a widely discussed topic between parents and kids, but it needs to be.
While saving money and making educated financial decisions is important, is deciding between purchasing one $4 toy or saving $4 going to make a huge difference in your child’s life? Not necessarily. On the other hand, is educating kids on how to use credit responsibly going to benefit them in the long run? Absolutely.
In this piece, I will talk about what good credit is, why it is important, and why you should discuss it openly with your kids.
What is good credit?
First, let’s establish what “good credit” is. Your credit score is measured on a scale from 300-850. Anything above 700 is considered a good credit score. The number you have is what lenders use to determine how likely you are able to pay back the debts you owe. As far as lenders are concerned, the higher your credit score, the more likely you are to pay back your debts. If banks view you as a small risk because of a high credit score, you can potentially qualify for premium credit cards and lower interest rates on loans.
Why is good credit important?
Having good credit will give you one major perk in life — options. With a good credit score, you can choose to make large purchases such as a car, sign a lease for housing, sign up for a new credit card, or obtain a mortgage. When you have poor credit or no credit, you have limited financial options.
Having little to no options in life can be suffocating. And my parents taught me this from the start.
My parents didn’t grow up with many options, so they knew they wanted options in their adulthood. They worked hard and built up excellent credit scores. They were able to purchase a second home and make nearly any purchase they wanted. And they taught my younger brother and me about the importance of good credit.
They gave us each an authorized user credit card at a young age, and they did this for multiple reasons. Most importantly, these cards allowed us to start building our credit history even as minors. Having a credit card was also safer than carrying cash, more convenient than always having to ask for money, and it gave them full transparency as to where we were making purchases.
Having credit cards also taught us the value they present to consumers in the form of rewards. I remember my mom bought her car on a credit card, and she used the credit card rewards to pay for Christmas that year. Since then, I have adopted the same mindset. As soon as I turned 18, I applied for my first credit card and have been earning rewards ever since.
While the rewards from credit cards are fun to collect, the main takeaway I got from my parents regarding credit was that good credit gives you financial independence. They taught me to use my credit score to my advantage. Because of this, I have never needed them to co-sign anything except for my student loans. I was able to qualify for an apartment and an auto loan, and refinance my student loans a year after graduating from college because of my established credit.
It is empowering to know that I have a great credit score, and I can make choices to set myself up for financial success.
If you want to start establishing good credit for yourself or your kids, here are a few tips.
Three tips for establishing good credit
There are five variables that make up your credit score. They are: payment history, debts owed, length of credit history, a healthy mix of credit, and new credit accounts opened. With this in mind, here are a few tips for establishing good credit:
- Open your first credit card. It can be a scary task, but it will help you establish your credit history quickly. You can start with a secured credit card or a student credit card if you’re in school.
- Make sure that you are paying your bills on time. If you are a day or two late, don’t panic. Just be sure to call your credit card company to make your payment. They will not report a late payment to the credit bureaus unless you are more than 30 days late.
- Keep your debts as low as possible. Part of your credit score is “debts owed,” which is also known as credit utilization. Said differently, it's the ratio of how much credit you have access to versus how much credit you are using. For example, if your total credit line is $5000 and you have a balance of $1000, you are using 20% of your credit.
How to teach your kids about financial responsibility
So how do you start teaching your kids great financial habits? Lee Huffman, founder of BaldThoughts and FinanceBuzz contributor, says, “Share how to manage your money, and how, when, and why you pay the bills that you have. Children don't need to know the exact numbers, but you can explain how you took out a mortgage to buy the home you live in, use a credit card to earn rewards (and pay off the bill in full each month), and how you borrowed money to buy your vehicle.”
Kids appreciate transparency, and having these discussions will give them an understanding of what a dollar is really worth. So here are a few ideas to start building your kids financial literacy:
Establish and practice excellent credit habits
Debbie Todd, a long-time CPA and co-developer of the learning platform Smart Money Commanders, says, “In the age of plastic versus dollars, it is easy for kids to slip into a false sense of security regarding how plentiful money is.” She goes on to reinforce how important examples are for kids to understand credit.
“In our recent class, we asked students to pick an item they wanted to buy. We then agreed on a price for the item. Next, we asked them to look in their “bank” to see if they had enough money. No, they did not, but we told them they could borrow the money, and monthly payments would be based on their credit score. Then we showed them two credit scores – one 575 and the other 770. Using an online calculator, we showed them the difference in the monthly payment and total cost, with the only variable being their credit score. It works wonders!”
Integrate personal finances into everyday activities
Lee Huffman has a unique way of doing this with his two kids. He explained that “when our children receive their paycheck every Friday, a portion goes to "taxes" and charity. The taxes go towards family expenses, and the charity money is saved up to buy toys and school supplies for needy families.” I love Huffman’s idea as it has personal finance, taxes, and giving back all rolled up into one lesson.
Open an authorized user credit card for your kids
Opening an authorized user credit card for your kids is an excellent idea. You can open your child an authorized user credit card at the age of 13, and put the card away in a safe place. Even if the card isn’t actively being used, credit history is still being built as you keep the primary card open. My parents did this with me, and it was highly beneficial.
However, if you think your child is ready for a credit card, give it a try. It is good to give kids some responsibility, along with transparency. Let them know that the card is to only be used for specific purchases or emergencies. Additionally, inform them of the consequences if they misuse the card. For example, if you give them an allowance, you could use this to “charge” them for any misuse. On top of this, talk to them about the concepts of late fees and interest. Lastly, sit down with them each month for 10-15 minutes and review the credit card statement. It can teach them the power of credit cards and how they can help you build a strong financial future.
While my parents did a great job teaching me the importance of good credit, they didn’t do such a great job with managing money. They are the poster children for “lifestyle creep”. The minute they experienced a financial gain, they would spend it on improving their lifestyle. So the improvement I’m making in my life is saving and investing for the future, rather than making frivolous purchases and not making forward progress.
The final word on teaching your kids the value of good credit
Again, teaching your kids financial responsibility and the value of good credit can be very difficult, but it’s important. Think of it this way: Your children inherit your genes, but they will also inherit your financial habits. If you can establish healthy financial habits for yourself, those have a very good chance of being passed on to your kids.
Having an excellent credit score will provide your children with options in life. These options will give them a shot at a life they are satisfied with. Begin teaching your kids the value of good credit by talking to them about it and modeling good financial habits. While explaining the concept of credit to your kids may seem challenging, they will benefit immensely from this knowledge. I sure did.