Teaching teens and young adults about good credit: a parent’s guide
Financial health isn’t something we tend to think about much when we’re young – for good reason. With so much life ahead of us, and usually very little in the way of disposable income, most teens and young adults don’t pay much heed to factors like savings accounts, investments, or their credit score.
But, as anyone trying to make a big purchase will tell you, these are all things that can come back to bite you if you’re not careful. A credit score in particular shows banks and other loan issuers how reliable you’ll be with their money.
If you’re a parent who’s concerned about their child’s financial future, there’s no time like the present to start taking action. In this handy guide, we’ll discuss what you can do to educate and prepare your kids for their next steps in life. From helping them understand the dos and don’ts of good credit, to showing them what to do to keep track of their score, this one-stop-shop is a handy way to introduce financial health to a younger audience.
Understanding what credit is and why it’s important
Because of the long term impact it can have, it’s important for a younger person to understand the value of credit and how it will impact their life. The best way to do that is by understanding what credit is to begin with, as well as the kinds of life events that will be impacted by having either a good or bad score.
A simple way to explain credit is by telling your teen to think of it as an amount of money they’re borrowing, that needs to be paid back in regular instalments. However, it’s important to stress that the money will need to be given back as agreed, in order to avoid fees and penalties. It is not “free money” to do with as they wish.
By its nature, credit is something of an abstract concept. That’s what can sometimes make it harder to manage, and often leads to confusion over how to achieve a good credit score.
Most of us know that your score is a “report card” of sorts, which allows creditors and banks to understand how good you are at managing money. One of the easiest ways to show a teen what it means to have good credit is to break it down by how a score is calculated:
- Payment history. This refers to making payments on time when using a credit card, or for something like making monthly instalments on a phone bill.
- Credit utilisation ratio. Most lenders aren’t looking for you to use all of the credit you’re given. They want to know you aren't relying on “borrowed money” to be able to afford your regular life. When this does happen, someone is said to be using 100% of their utilisation ratio. Instead, it’s good to aim for a ratio that sits around the 30% or lower mark. That means if a credit card has £1,000 available on it, spending more than £300 per month (30% of £1,000) might hurt your utilisation ratio.
- Credit history length. The longer your accounts have been active, the better. This shows a lender you’re more likely to be reliable, and also gives a clearer picture of your financial habits over the years.
- Hard credit checks. The last part of your score is made up of hard credit checks. This is what happens when a lender looks at your history to see if you’re reliable enough to lend money to. The less you have, the better. This happens every time you apply for credit, so it’s best not to do that too often.
To make credit feel a little more real to a young person, it can also be valuable to explore scenarios where a credit score might impact them in the future. These examples might not be things they’re concerned about right now, but it’s likely that at least one of the following will strike a chord with their lifetime goals:
- Getting a mortgage
- Getting a loan for a car
- Getting better interest rates on loans
- Saving money on insurance
What you can do to help a teen build good credit
So, what steps exist to make it easier for you to steer your child in the right direction? The help a parent can offer will vary from immediate practical changes, to casually encouraging the right kind of mindset for managing money.
- Master the financial basics. The earlier your child begins to understand the basics of money management, the easier it will be for them to adopt good habits when it comes to credit usage. This could be something as simple as teaching them how to save money every week, or more complex lessons like creating a budget and tracking their spending.
- Use prepaid debit cards. Serving as the perfect bridge between independent money management and the bank of mum and dad, these cards let kids spend, but with flexible controls for parents. It’s also possible to get real-time spending alerts, which can be approved or rejected.
- Let them manage a current account first. Current accounts, which give a teen the chance to spend using a debit card, are a good first step into the world of adult finance. This allows them to make small mistakes without it affecting them too much in the long term. They won’t be able to spend more than their overdraft (if they have one at all). Making sure they’re only spending what they can actually afford is a big step in encouraging the healthy use of credit when the time eventually comes.
- Add them to your credit card account. Adding a child to your credit account could be the perfect way to introduce them to the world of credit payments. This does come with the risk of them overspending and affecting your own score though, and different banks and credit providers will ask for varying ages for a child to be added to an account. If you are able to, and you trust them, consider giving them their own card. This historical data can help contribute towards their credit score when they turn 18.
- Cosign for them. It can be tricky to get approved for a loan if you don’t have much credit history. Cosigning is a good alternative for parents wanting to give their kids a nudge in the right direction. This will mean both of your names are on the account, even if they’re the only ones using it. Again, be aware that any mistakes they make could also impact your score.
- Have them registered to vote. As soon as they’re allowed to (the age varies depending on where you live), adding a teen to the electoral roll helps to give them a financial identity in the eyes of credit agencies. This will help financial bodies confirm their personal details are correct, which in turn allows them to build a rounded and accurate picture.
- Lead through example. One of the most effective ways to teach someone who looks up to you, is to educate them through actions. That’s true when kids are really young, and carries through all the way into early adulthood. Their first touchpoint with any kind of money management is going to set the tone for how they approach finances all throughout their life. Don’t spend recklessly, and even consider sitting them down and explaining how you’ve been able to manage your own budget. You can also show them how different types of payments, such as a car loan or mortgage, work.
Educating a teen on credit mistakes
Part of good credit management is knowing what the opposite end of that spectrum looks like. Understanding the pitfalls of credit is the easiest way to avoid them altogether:
- Not making a payment. The most obvious mistake someone can make with credit payments is failing to make them. This will count as a negative mark against an account, which could impact its score for the next few years.
- Paying the minimum balance. When making payments it can be tempting, even understandable, to want to pay the minimum amount possible. This number is usually offered to account holders when their monthly balance is calculated. In reality, doing this will mean interest gets added to the account. This will build over time, making the amount you owe higher and higher. It also means your utilisation ratio won’t drop, which could negatively affect your score.
- Withdrawing cash. Taking out cash with your credit card could cause your account to be hit with high fees and a large interest rate. It can also be a warning sign to lenders that you’re in need of cash quickly, which could make them question your ability to manage your money.
- Chasing rewards. Some credit cards come with rewards for spending a certain amount. These might be in the form of points or discounts, working off a system of about 2% cashback for every £1 you spend. The interest you’ll accrue will probably be higher than 2% if you don’t repay your balance in full, which means you won’t benefit from them if you carry a balance.
- Treating credit like “free money”. The biggest misconception about credit is that it’s free money to spend on whatever you want. While you can definitely make big purchases, doing that without the money needed to immediately pay them off will see you build a large sum of debt – which will grow thanks to the interest on the card. The general rule of thumb is to only ever spend on things you can already realistically afford with your debit card. Credit is a tool to show banks and lenders you’re reliable with money, not a way to get expensive items for “free”.
- Letting credit debt build. Ignoring debt is never smart. It can negatively impact your financial health in a number of ways:
- Making it harder to get approved for a loan or mortgage
- Causing interest payments to accrue on your account, which compounds your debt
- In extreme cases, lenders might call in debt collectors to get back some of the money they’re owed
How to monitor a credit account
Vigilance is an important aspect of successful money habits. Keeping an eye on your credit score can make it easier to spot mistakes, as well as take the right course of action in order to improve it. Whether you’re monitoring it for them, or teaching how to do it themselves, here are some ways to keep track of credit health:
- Credit reports. You can always check your credit report for free online. This should be possible through any of the major agencies – such as Transunion, Experian, and Equifax. You’ll need to sign up with these organisations in order to get access to a report whenever you like.
- Third-party providers. Some websites also exist that let you check your credit score with these major agencies. In most cases, these sites will only show you one score, depending on which agency they use. They’ll also offer you promotions and deals on specific loans.
- Your bank. While not always the case, some banks allow you to check your score easily when accessing your online account. While the score itself isn’t hosted by the bank, they can quickly transfer you to one of the major agencies.
Good credit and wider financial habits are best built when you start young. Think seriously about sitting down with a teen or young adult to help them with theirs – it could be one of the most valuable decisions you make as a parent.
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The Editorial Team - Compare the Market
Experts in personal finance, insurance and utilities
Compare the Market’s Editorial Team is made up of industry experts with decades of experience in personal finance, insurance and utilities. Each of our authors has an area of expertise, where they can share their extensive experience to help you get a better deal, by finding the right product and saving money.