Credit Card Lessons for Kids

Introduction

They really mean it when they say that kids grow up so fast.

One day, you’re teaching them all of life’s lessons. Suddenly, they’re a young adult living the life you helped set the foundation for.

You want your kid to be as prepared for life as possible, especially in areas like personal finance and credit that have a huge impact on our day-to-day lives.

Many people have to learn about credit cards on their own — sometimes through making otherwise avoidable mistakes. But that doesn’t have to be the case. With the right plan, you can help set your kids up for success.

Credit Cards for Kids

“If I knew then what I know now…”

You’ve probably heard or even uttered a version of that at some point. And there’s a decent chance it was in reference to something financial.

According to a US News survey, just 52% of respondents reported that they understood how credit worked when they began using credit cards. And only 11% said they haven’t made any major mistakes when using credit.

Teaching your kids about credit cards ahead of time can help them make informed choices and avoid potentially costly mistakes.

Why Credit Education Matters

Kids should know about credit because it will have an impact on many important life milestones.

The loans used to buy a house or a car, the credit cards that allow you to pay for utilities or other services online, and even some job applications all involve a credit check at some point.

To put it lightly, each of these things is a big deal, so it’s a good idea to go in prepared.

Think about it: Students study before tests, runners train before a race, and employees rehearse before a presentation.

It makes sense to prepare for something important and credit is no different.

For example, teaching your child how to use a budgeting system can help prevent overspending and lead to responsible debt management. At first, this can be as simple as having a talk about “wants vs needs.” Over time, you can build on that.

This practice can be good for their credit scores, and their overall finances as well.

Parent Action Plan

Helping your child to develop good credit behavior takes time, patience, and reinforcement. But it’s all a little easier with a good plan.

Here are some essential lessons and actions to consider that can help with teaching financial literacy and even start building credit for kids.

Explain how credit works

Tell it to your child straight: Credit is not free money. Let them know that misusing credit can come at a price.

You may want to simplify things or even turn the discussion into a game, because lecturing your kids on the nuances of higher interest rates, lower credit scores, late fees, and such could just put them to sleep.

From there, stress that how they manage a credit card could affect their lifestyle and future financial options. Accentuate the positive. Explain that good credit and responsible credit behavior could open doors and present opportunities they might not otherwise get with poor credit.

Introduce credit scores

Children of pretty much all ages understand the concept of games and keeping score. They know that a high score is something to feel proud about and a low score means there’s room for improvement. Explain to them that a credit score is essentially a number — ranging from 300 to 850 — that lets them, and others, know how they’re doing in the “game” of credit. Share your credit score with your child. If it’s not as high as you would like it to be and you’re not proud of it, explain to them why it’s important to you to improve it and how you plan to do so.

Talk about credit reports

If your child is in school, they should understand the concept of a report card and how it reflects their performance in the classroom. Let them know that a credit report is essentially the same thing, only it paints a picture of how you’re performing in the real world when it comes to managing your credit. Explain that credit card companies, banks, and other companies share information with the three major credit bureaus — Experian, Equifax, and TransUnion — and that each of these agencies uses this information to generate a credit report.

Pull your own credit report and use it as an example. Go over each section, including your personal information, accounts, and inquiries and talk about how it affects your family’s finances. Stress the importance of reviewing your report regularly to make sure it’s accurate and up to date.

Discuss credit utilization

Children often think that more of something has to be better, but it’s up to you to teach them that, when it comes to credit, this isn’t always the case. If they’re old enough to understand ratios and percentages, explain the concept of credit utilization.

In simple terms, this is how much of your total available credit you are actually using. If someone with $1,000 available credit is using $300, their credit utilization ratio is 30%.

Experts even recommend keeping this ratio below 30%. If your child gets an allowance, give them 30% of it to put the concept of this percentage into a tangible example they’ll better understand.

Take advantage of family budgeting apps

If your kids are going to have some screen time, it might as well be quality time, right?

There are many budgeting apps out there, but some are specifically designed for kids. These include Greenlight, BusyKid, FamZoo and Acorns Early.

Each app has its own approach, but they generally allow kids to save, spend and sometimes invest, all with parental approval and oversight. They usually come with a debit card, an allowance feature and educational content, like quizzes.

These apps are a great way to help kids learn by doing. And since these apps involve input from parents and kids, this can help make their credit education feel like a collaborative project.

Add your child as an authorized user

Finally, you can give your child a more direct leg up by piggybacking on your own good credit habits. Adding your child as an authorized user of your credit cards can start building their credit report.

However, the effectiveness of this depends on the issuer of your card. Some may only report authorized user activity by spouses, for example. And some don’t allow authorized users under a certain age, like 16.

How Credit Impacts Future Opportunities

It’s also a good idea to explain to your child that practicing good credit behavior is not a temporary thing. It’s a lifelong commitment.

For example, good credit can affect career prospects, because desirable employers often perform credit checks before offering a job.

And of course, good credit means better chances of being approved for credit cards, student loans, home loans and car loans. But it also leads to better terms on credit, which can have a huge long-term impact.

So, it’s typical to repay a home loan over the course of 30 years. And your credit score will determine the APR — the interest rate — you are offered on that loan.

To show the impact of APR, let’s do some quick math with a round amount of $100,000:

• Loan 1: $100,000 borrowed at 6% APR, 30-year term
  • $599.55 monthly payment
  • $215,838.45 total payments
  • $115,838.45 total interest charged
• Loan 2: $100,000 borrowed at 7% APR, 30-year term
  • $665.30 monthly payment
  • $239,510.98 total payments
  • $139,510.98 total interest charged

That single percentage point makes a difference of $23,672.53 over the course of our example loan. And considering actual mortgage amounts and rates, a better APR can add up in the long run.

Having good credit isn’t just a foot in the door with lenders, it can mean saving a significant amount of money.

Common Credit Mistakes Young Adults Make

Young credit card users might encounter some common pitfalls which can lead to some tough situations if not avoided — or at least course-corrected.

Overspending is one of the most common mistakes.

For some people, the first time can serve as a reminder to better track spending in the future. But if overspending becomes a habit, that card balance is only going to grow, with interest charged on top.

In addition to the financial burden, carrying a high balance can negatively impact credit utilization ratio, which is an important factor in calculating credit scores.

If the overspending gets too far out of hand, that can lead to another common mistake. And that’s missed payments.

Payment history is the most important factor in calculating credit scores and missing one payment by even 30 days can drop your credit score by 100 points. And missed or late payments can lead to fees and an increased APR. That, in turn, can make it even harder to get back on track.

If you want to emphasize the importance of payment history, teach your kids this simple phrase: Pay on time, every time.

Bottom Line

With the important role credit plays in our lives, it can be a huge advantage to understand how it all works ahead of time.

Many people don’t start their journey prepared, so educating your children about credit can set them up for success in life and help them avoid common mistakes that could take years to bounce back from.

It’s a worthy time investment that will likely make their lives much easier. And it may not seem like it now, but someday they will be thankful for the lessons. That’s a promise.