Like it or not, our society leans heavily on credit scores to measure your level of responsibility and financial risk. Your teenager’s credit score will be used as a litmus test to decide whether they are accepted for credit cards, a cell phone plan, personal & auto loans, insurance, apartments, jobs, and the list goes on and on. As they head toward full-fledged adulthood, you can help build a credit history to cast your teen in their best light.
How Can I Help My Teenager Build Credit? The easiest ways for your teen to establish a credit history are through the use of readily available financing tools such as:
- Secured credit card or “credit builder” installment loan
- Joint or co-signed credit card account
- Non-secured loan or credit card
- Non-profit Lending Circles
Don’t underestimate the power of a solid credit history. The holy grail of a high FICO score is a long term resource that will help your teen navigate financial events throughout a lifetime. When your teen understands the mechanics and power of credit, they’re more likely to begin building their credit history with intention. You can help them by using your knowledge, experience and potentially your own good credit history. Start here to help your teen make the best choices, avoid pitfalls and build their credit profile with an eye on the long-term gains.
And if you’re a little quick on the draw with your own credit card, use this as a chance to build good habits alongside your teen. It can be disarming for teens to learn something new with parents who will admit past missteps. Our own teens love the idea that we don’t know everything. Yep, we readily admit some solid mistakes under these belts. Very satisfying for all.
First, Set Rock Solid Expectations About the Use of Credit
Samurai Mom and I have a specific point of view about building a credit profile in the teenage years. Teens can build money habits during these years that can help them transition to financially responsible adulthood. The opposite is also true – teens can also “inherit’ bad money habits that will set them back throughout their lifetime.
Without some guidance, teens may fall into the spend now and deal with the consequences later trap. To be clear: this article is not about engaging in rampant consumerism and accumulation of debt. There are many quality resources out there to teach your teen the basics about personal finance, budgeting and the consequences of carrying debt. They may have had an introduction in school, also. Before you move forward on any of the tools below, have that level setting conversation with your teen that this is ONLY about building credit and not about carrying debt in order to buy more stuff.
Tip: Start your teen off with a checking account. Teach them how to balance it down to the penny. Their ability to manage the account will give you a good indication of their readiness for credit.
How Long Does it Take to Establish Credit?
Establishing credit is not immediate, so you have some time to help create good habits. Credit score calculations are based on your teen’s payment history over time. It can take anywhere from three to six months for the credit reporting agencies to have enough data to calculate a credit score.
After you have identified the type of credit account you’ll be opening, expect there to be a week or so approval time after application. Then, unless you pay for expedited shipment, it will take 5-7 business days for your card to arrive in the mail. From the time you first use your card to the time you receive a bill can be several weeks depending on your statement closing date. Add time for the financial institution to apply the payment to your account and finally, 30 to 45 days to report your first data point to the reporting agencies.
These methods below allow your teen to slowly build a profile using secured accounts, or an extension of credit that is guaranteed by a deposit.
What is a secured credit card?
A secured credit card is a tool used when you are unable to qualify for a traditional non-secured card. The issuer will require a deposit into an interest-bearing account as security. The cardholder then uses the card to charge items in the same way as a typical credit card. For your teen, this could be a good option if they have a low monthly expense that they could set up an auto draft to pay the full balance on time. By paying the full balance each month, your teen will pay no more than the annual fee. The credit limit of the card is usually the amount of the deposit. After they’ve paid their card on time over the course of several months, they’ll likely qualify for a non-secure card. When they close the account, their deposit will be returned. But keep in mind that the length of time an account is open is a key factor in the credit score calculation.
Teen Tip: Use this card only as a credit builder. Set it up to pay for a low predictable recurring monthly expense like a Spotify Premium for Students subscription for about $5 a month.
Bonus Teen Tip: Pay the statement balance in full each month to avoid interest expense. Keep your account balance to credit card limit at 30% or lower. Banks call this the utilization rate. For example, a month-ending balance of $135 on a $500 credit limit is a 27% utilization.
What is a Credit Builder Loan?
A credit builder loan works like a savings account in that at the end of the loan term the money is yours. The “loan” funds in the account are frozen until your loan balance decreases through payments or until the end of the term. The lender may even refund a portion of the interest back to you as well.
How it works – When your teen applies and is approved for the loan, a savings account is funded on behalf of your teen. The amount funded represents the principal of the loan or, the amount he needs to pay back through monthly installments. The lender charges interest as with any other loan. So, shop around to get the best loan. Also, make sure that they report payment history to at least one of the major credit reporting agencies.
Where can your teen get a credit builder loan? These loans are not widely available since there is little profit in it for the lender. Start at a credit union or a community bank. Credit unions typically service a specific group of members. There may be qualifiers for a membership like living or working in a certain area or working in a specific trade or profession. Achieve Financial Credit Union is open to anyone and the requirement to become a member is opening a savings account with a minimum of $5.
Can You Use Your Good Credit to Help Your Teen?
When I started college, I was a commuter and had a part-time job to cover my expenses. My mom suggested that we open a credit card together. She co-signed my first credit card with a very low limit of $500. It was enough to fill up the car at the gas station but not too much where I could rack up serious debt.
Before we applied, she and I sat down and talked about what a credit card really was and how to use it responsibly. Over her reading glasses, she stressed that she was financially obligated to this card. She expected and confirmed my commitment to pay the card in full every month before the due date. The good news was that with a $500 limit it was always manageable. I held on to the card through college and built a good credit history in the process. Later in college, I moved closer to school and had an apartment. The credit that I built using that card helped get me into that apartment.
Another option for helping your teen get started using a non-secured card is to make them an authorized user on one of your cards. The teen gets a card in their name with a built-in benefit of an established account. There’s usually a long account history and pattern of positive payment activity. You get the benefits of being able to keep an eye on the statement activity and due dates while building trust between you and your teen.
General Tips to Protect an Account
There are a few things I do with every credit card I am issued whether there are other authorized users or not. I always:
- Call the bank and ask them to prohibit cash advances
- Log into my account and set up text and email activity alerts
- Set up available fraud/security alerts
These steps will help you keep control.
Tip: When adding your teen as an authorized user, ask the card issuer if you can set a spending limit on authorized users.
Non-profit Peer Lending Services for Building Credit
Another possible way for your teen to build entry-level credit is to join a lending circle. A non-profit lending circle is a group of people from the community that come together with a common goal. The group raises cash through automatic monthly contributions by its members. Those funds are used to create small loans for each member of the group in turn at 0% interest. In partnership with an organization like Mission Asset Fund, the local community group’s sponsor reports the loan repayment to the three major credit agencies. The goal is to establish or increase credit scores of each of the members.
Establishing a positive credit history will benefit your teen throughout his or her adult life at every turn. It can open doors to getting a reliable mode of transportation and even buying their first home. In addition, a good credit score will save them money in credit rates, other borrowing costs and insurance premiums. A good credit score will also put them in a stronger position to qualify for an apartment or even employment. A teen that builds their credit history with intent is much more likely to be prepared for the financial challenges of adulthood.
What are the Key Factors in Calculating a Credit Score?
- Payment history
- Credit Utilization
- Mix of credit account types
- Length of time accounts are open – aging
- New accounts
Experian reported the average credit (FICO) score by age group as of 2018:
- 18-29 years old: 659
- 30-39 years old: 677
- 40-49 years old: 690
- 50-59 years old: 713
- Age 60+: 747
What is a Good Credit Score?
According to Experian credit scores typically break down in the following categories:
- 800+: Exceptional
- 740-799: Very Good
- 670 – 739: Good
- 580 – 669: Fair
- 579 or below: Bad
How Old Do You Have to Be to Get a Credit Card?
Per the Credit Card Accountability, Responsibility and Disclosure Act of 2009, anyone under the age of 21 has the following restrictions to opening a credit card account. They must:
- Have a co-signer above the age of 21 and that has the means to repay debts incurred
- Submit financial information showing they have independent means to repay the debt incurred