Charge It, Junior: Should kids have a credit card?
A recent inquiry from a client made me rethink if kids should have a credit card. The client’s daughter had recently applied for a mortgage on her first house and the lender was hesitant because the daughter didn’t have any credit history. She had religiously followed the adage of avoiding credit card debt to avoid paying interest, but the unintended consequence resulted in little information in her credit report which made banks skittish to lend to her.
As a result, I thought it would be helpful to reverse the rule of thumb of avoiding debt to encourage appropriate use of debt as children mature into independent adults. The emphasis is on “appropriate use” so don’t misinterpret to think I’m suggesting it’s worthwhile to max out your credit card to spend the next two decades paying it off!
According to myFICO.com, your credit score is comprised of five components including payment history, amounts owed, length of credit history, new credit, and credit mix. Making payments on time has a huge impact on your credit score while length of credit history includes how long you’ve had credit as well as the average age of your accounts.
The amounts owed is a function of your utilization rate which is basically how much of your limit you regularly use. For example, if your limit is $5,000 and you charge $4,000 in a month, the utilization rate would be 80%. Ideally, you want to keep the utilization rate below 30% (less than $1,500 if your limit is $5,000) by either charging less or increasing your limit.
Starting out, it can be difficult to establish credit as companies are less likely to extend credit if you don’t already have credit (which is frustrating since the intent is to establish a credit history). One solution is to add a child as an “authorized user” to an existing credit card owned by the parent. Caution is warranted as the card owner is ultimately responsible for the authorized user’s charges. In addition, make sure the company reports the activity on the authorized user’s credit record which is not always the case.
Individuals can apply for their own credit card at age 18 although they typically need proof of income. An alternative is to use a secured credit card which typically requires a security deposit to serve as collateral. There are also credit cards specifically for college students.
A couple of helpful websites for managing credit and personal finance decisions include nerdwallet.com and creditkarma.com. One of my favorite books for parents or grandparents on the topic of educating children around positive financial habits is “The Opposite of Spoiled: Raising Kids Who are Grounded, Generous, and Smart About Money” by Ron Lieber.
As seen in the Racine Journal Times/September 2020
