Building a good credit profile is something everyone has to consider when they reach adulthood. But really, the lessons on managing credit should start earlier. What’s more, teenagers can actually start to build their credit profile before they’re technically allowed to access finance. Here, we’ll explore some top tips for helping your teenager build their credit rating for when the time comes.
Teaching your teenager about the dangers of poor credit management
Most important, is understanding the dangers of poor credit usage. A poor credit history can have wide-ranging consequences. This can range from:
- difficulties finding housing, whether renting or buying
- difficulties when applying for jobs as employers can access your credit score
- higher costs for car insurance
- higher interest rates on loans or inability to take out loans
- mental health impacts of credit-related stress
For more information, take a look at this guide from Investopedia on why bad credit management can cause issues in the future.
The most important lessons to teach teenagers about credit:
1. Its not your money and its not free.
Being able to access finance on credit does not make the money your own. By using credit, you sign up to an agreement with a lender to use their money to make purchases which you pay off in future. This involves interest rates, which means you’ll pay more than you borrow and should never be considered your own money.
2. It’s not something to be relied on
Credit should be used for one-off purchases which you wouldn’t usually be able to afford without major saving. Typically, it is used for expensive purchases like buying a house or a car. It’s important your teenager knows that credit shouldn’t be used for purchases which don’t serve a beneficial purpose. They should also be aware that signing up to credit which is outside of their means can be a form of fraud if they lie during their application.
3. You should do everything possible to avoid missing payments
Missed payments are marked on your credit profile. This means that future lenders will be able to see how trustworthy a potential credit applicant is and decline them based on that knowledge. While purchases like a new games console may seem the most important thing at the time, it’s not something that should be given prominence over a mortgage later in their lives. And if poor management of bill payment does occur, it’s very likely that they will face difficulties when it comes to future applications.
4. Communication with the lender is key and can help prevent further issues
A key principle to teach your teenager about credit is the idea of honesty and communication. Lenders are obliged by law to make sure your payments are affordable and they must do everything within their power to help. If you can’t make the required payment, your lender will likely lower your expected payment or provide other forms of assistance such as payment freezes. But this can only happen if they are aware of the problem.
5. Mistakes won’t be forgotten about soon
Marks on your credit score can remain for a long time, often up to 6 years. These marks will be used to judge your credit-worthiness by other credit agencies, banks, employers and housing providers. What’s more, by not paying your bills on time you are at risk of default, CCJs or bankruptcy. These are all poor signals which cause major financial difficulties in later life.
6. Credit can be useful
A final lesson is that credit can be useful when managed correctly. Things like mortgages and cars on finance are commonplace. They help people without inheritance or major savings to afford things their monthly wage would not usually allow. Adopting a sensible approach to credit means you are afforded the chance to make purchases which are beyond your current capabilities. No doubt your teen has aspirations for the future and credit may be something that helps, whether that’s for setting up a business, buying a house or purchasing a car.
Tips to help your teenager build their credit rating
So, while credit is something to be treated with care and caution, it can be useful. But to get credit, your teenager will need to show the right signals to lenders. Here, we identify ways your teen can start building their credit before they’re 18 and available to apply for it themselves.
Some mobile phone service providers offer under-18s the chance to use their bank account to pay for their mobile phone. The contract will typically have to be under a parent’s name but can still help their own credit profile. However, it does mean the parent will take all legal repercussions for missed payments, so responsibility is key here. But with the monthly bill being paid for from their account, credit-worthiness can be built and good signals created for future lenders.
Consider a prepaid card
For younger teens, a prepaid card is a great way to get them into the habit of using finance for important purchases. It also allows them to understand the principles of budgeting. A prepaid card is not really a credit card and your teen will only be able to spend what you deposit. Although, prepaid cards often come with fees so it may be worth only using one of these to test their responsibility before co-signing on an actual credit card.
Authorised credit card use
As mentioned above, credit can also be used by teenagers if they co-sign on their parent’s card. Through this process, they can be placed as an authorised user and given their own card. With sensible use, signals can be shown to future lenders that they are responsible when it comes to managing money. This can help with applications for credit further down the line.
Clearly, it’s important to set specific rules and boundaries to ensure your teen isn’t causing you any financial troubles. It’s worth taking out a card with a low credit limit and a maximum spend to avoid any charges or other nasty surprises.
Open a savings account
Getting your teenager to open a savings account and make monthly deposits can show lenders their ability to manage money. Not only will these deposits be noted on application, but the surplus cash is a great signal that they pose low risk to lenders.
Put a household bill in your teenagers name
Giving responsibility of a household bill to your teenager is a great way to show lenders credit-worthiness. This has also has the dual purpose of getting them used to the idea that money needs to be saved and ready to be taken from their account on a certain date.
Introduce them to credit ratings
Involve your teen in your family finances and share your credit rating with them, whether good or bad. Of course you won’t want to cause any stress but if you think its safe, allowing them to see the mistakes you’ve made and how that affects your report can give them a clear example of the repercussions of poor finance management. While doing this, you can introduce them to the key concepts such as the credit score, defaults, missed payments and more. It’s also a good idea at this to make clear that banks have access to this and will use it to make decisions on whether you can access credit further down the line.
Finally, a key concept of helping your teenager build credit is to show trust. Once you’ve implemented ground rules and ensured they understand the gravity of credit use, you should trust them to go and use credit in a sensible fashion. Of course, your judgement is key here. If they’re not ready, they’re not ready – simple as. But as all credit agreements are based on mutual trust, at some point they need to be given the chance to show they can manage credit and manage it properly.