Good credit is better than bad credit, that’s a fundamental truth. Like it or not, our credit and credit score impacts so many aspects of our lives. Good credit allows us to pay less for cars, homes and insurances, and bad credit can keep us from getting the job we want.
Because of the important role it plays, teaching your kids about credit is imperative so they can avoid falling into the credit trap.
The credit trap is something many Americans fall into at some point in their lives, myself included.
Currently, the average American family has over $6,000 in credit card debt. Many are stuck in the cycle of rolling balances over from month to month, incurring large interest charges on those balances, and only making minimum monthly payments.
In that scenario, your balance keeps growing and it can be harder and harder to get out of debt.
Here’s another fundamental truth I’d like for you to keep in mind; if you can’t afford to pay with cash, you can’t afford it. Now, this doesn’t mean you shouldn’t use credit cards, it means you can buy things with credit cards only if you have the money in the bank.
There are a couple of exceptions to this rule like your house and car.
What I want, and I’m guessing you want, is to have financially successful children. Helping them become good stewards of credit will go a long way to helping make that desire a reality.
Here’s what we’ll cover:
- Understanding credit
- The problem of credit
- What are the factors that go into a credit score?
- Improving your credit score
- Credit cards
- Being a good steward of your credit
Let’s get started.
Understanding credit
Your creditworthiness speaks to your ability to repay money you borrow. A potential lender wants to know that they’ll get their money back should they lend it to you.
A credit score is a number from 300 to 850 that measures your credit-worthiness; meaning your ability to pay back money you borrow.
Banks want to lend money to people who are likely to pay them back. With that in mind, the cost to borrow money for someone with a credit score of 850 will be less expensive than the cost for someone with a credit score of 300.
A credit score above 700 is considered “good,” and working to get a credit score of at least 620 is a wise initial goal because that will allow you to do things such as quality for a conventional home loan.
The problem of credit
Credit in the form of a line of credit or a credit card can provide a false sense of security. It’s not an emergency fund and to think of it that way is a mistake. Don’t believe me? Then you’ve never had your credit line pulled, or your credit limit reduced.
And those things happen at the worst possible times.
During the financial collapse in 2008, that happened to a lot of people, myself included. When times get rough and uncertain, banks become much more cautious about their lending.
The Fair Credit Reporting Act tells us that credit card issuers have the right to lower credit limits whenever they want. If you make late payments or carry high debt and only make minimum payments, the issuer may reduce your limit.
This can lead to a perfect storm of you needing money in tough times, only to have your limits decreased.
You need an emergency fund that is in cash, learn more about how much in this post.
What are the factors that go into a credit score?
There are many factors which go go into your credit score
- Your history of bill payments (Do you make your payments on time)
- How many credit accounts you currently have
- How you’re using your credit (also known as utilization)
- How long you’ve had your credit accounts
- Recent applications for new credit
- Any negative history such as collections, foreclosure or bankruptcy
Again, these are objective measures lenders use to determine how likely someone is to pay back the money they’ve borrowed.
Improving your credit score
There are a lot of ways to improve your score, some which may seem obvious
- Properly use your credit and make all payments on time. If you’re able to set up automatic payments, that can help ensure on-time payments
- Reduce your utilization to 30% or less. If you have $10,000 of available credit, bring your balance to $3,000 or less
- Pay off existing debt
- Keep old accounts open
- Reduce the number of new credit applications. If you must open new accounts, proactively try and open them around the same time
Here are the main ways to hurt your credit and lower your score
- Making a late payment
- Having a utilization ratio about 30%
- Applying for multiple credit accounts at the same time
- Closing credit accounts
Credit cards
A credit card is a financial product, and like all other financial products, they are not free. They exist to make the issuer money. In exchange for the credit they are extending you, you will pay them.
Credit cards may be a good way to start building your child’s credit score, as long as you’re smart about it.
Credit cards versus debit cards
While these two types of cards appear to be similar, they can be very different. A debit card is similar to paying with cash. When you make a purchase, the money goes directly from your bank to the vendor.
With credit cards, when you make a purchase, you are paying for it with the issuer’s money.
Commonly, credit cards offer more protections than debit cards, but that protection comes with the cost of the card. As you’re making decisions about which cards to use, be sure to check the details of the particular card.
Features of credit cards
Credit cards have limits, meaning the amount of credit the issuer extends to you. You pay an annual percentage rate (APR) on all of your purchases. This means you pay interest on the money you borrow.
Many credit cards have annual fees and expenses. If you make late payments, you often pay penalties.
Credit cards also incentivize you to use them by offering you points or rewards. Be sure to educate yourself on how these programs work so you’re able to maximize the benefits and minimize the costs.
In case of emergency
I’d rather my kid had a credit card with them in case of emergency. But it’s important to define and be clear in what constitutes an emergency. Finding an awesome deal on a pair of shoes isn’t an emergency, neither is forgetting to pack a lunch.
Adding minors to your account
Kids can’t get their own credit cards until they turn 18. You may be able to add your minor child to one of your existing credit accounts.
Should you decide to do that, be clear in what the card is to be used for, and what it’s not. Each credit card issuer is unique, so you’ll need to check with them to see at what age they allow a minor to be added.
Getting a secured card at 18
Once your child turns 18, a secured credit card is a good way to help them begin using credit responsibly. As it sounds, you make a security deposit to the issuer, and your child gets their own credit card. Again, every issuer is different, so make sure you understand the details.
Being a good steward of your credit
What gets measured gets managed. To help your kids be good stewards of their credit and good users of credit cards, you need to monitor your spending every month. I can’t tell you how often people tell me about checking their credit card statements once a year and finding purchases that they didn’t make.
It’s also a smart practice to review your credit report every year. There are many sites which will provide you with a copy of your credit report at no cost. This is an exercise you can include your kids in so they know what a credit report looks like.
On a monthly basis, I encourage you to have a brief family meeting to go over family finances. Talk about upcoming things you’re saving and budgeting for. If you’re investing as a family, talk about how your investments are doing. And go through your cash flow and credit card statements.
A giant part of getting good with money is being intentional about it. Be as open as you can be about your family’s finances and let them ask questions. Doing so will help your kids develop positive habits which can serve them throughout life.
Resources
You can access our Get Out of Debt, as well as our Goals and Values courses at no-cost.
If you’d like to dig deeper, check out our Improve Your Credit course, and if you’re ready to take charge of your money, our DIY Financial Plan workshop could be for you.
On of our Certified Partners Dovly can help you monitor your credit.
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