One of the most impactful (and underrated) things you can do to help your kids get ahead in life is to help them establish credit. Helping your child build credit gives them independence and knowledge within Personal Credit and Finance, including providing the groundwork for how their finances impact their future lives. Most Americans don't even know they're able to help build their child's credit, and it really can save them thousands of dollars in the long run, as well as preventing you, the parent, from having to co-sign and put your own credit in a risky position.
If you have some of the following questions...
- How can I help my child establish credit?
- How should I build a credit score for my child?
- When can I start building credit for my child?
- Can you build credit before 18 years of age?
Then you're in the RIGHT PLACE, because this article has the ANSWERS.
Why Building Credit is so Important
Before we go into depth on the best methods to meet your goals, it's crucial you understand the VITAL IMPORTANCE of building credit early for your kids..
Let's talk Facts. Two of the three largest purchases the average "child" makes are: College and a Vehicle. Since most kiddos don't have a credit rating or standing, parents generally feel obligated to just put the loan in their name because they feel this is the only option.
Well, it's time to set the record straight...
If you build good credit for your child EARLY, it will have a positive effect on their ability to purchase things in their name, and establish and build financial literacy in the future.Even if you, as the parent, are looking to foot the bill, it's still so important that credit is established in your child's (or childrens') name early on.
Children are the largest and most precious responsibility we have for the first 18 years of their lives.
Unfortunately, this statement is only 100% true for 5% of families...
Plenty of parents are finding themselves having to support and pay for their kids well into their mid-to-late 30's now. In most cases, this could have been avoided had they been proactive with their child's credit early on.
Even if you are planning to pay for the Large Expenses for your children, it will still be advantageous to set them up with established credit so, when the time comes, they will be able to apply for credit without your help (and without being a burden to you).
The second Largest Purchase our kids make is on their Education...
A good Education is both COSTLY and PRICELESS...
With just a couple of small steps, you can build your child's credit early and set them up for life, costing you only pennies in comparison to what it COULD cost if you don't...
Why Does It Matter if I Co-sign?
If you have ever cosigned for someone, you already know the numerous risks you're taking:
- Messing up YOUR credit if THEY default on the loan.
One late payment will drop your own credit by 80+ points and a Charge-off/Collection can drop your scores 150+ points. Don't mess up BOTH yours and your child's credit by defaulting on a Joint Loan.
- It can hurt your ability to be approved for future Loans due to the Debt to Income Ratio.
Did you know that most people who get turned down for a loan think it's because of Credit? In most cases, it's actually because of Income or Ability to Pay for the loan. Most lenders only allow your Debt to Income to be 40-45%. This means if you make $3,000 a month, the total amount of debt a lender will allow you to have is $1,200 - $1,350 a month. So if you have a Car payment of $500 a month, a house payment of $600 a month, and cosign on a student loan of $200 a month, your total obligated debt is $1,300 a month. Let's say you want to purchase another car a year later. You would be at your MAX Debt to Income, and it's being affected additionally because of the $200 student loan. Although the student loan is not your obligation, it still affects you and your credit.
- It can cost you MORE on future Loans due to your Credit Exposure.
To build on the previous point, the higher your Debt to Income Ratio is, the higher your "RISK" is to the bank, so they will increase your interest rate to further extend loans, EVEN THOUGH the loan you co-sign on is not necessarily yours.
- Risk of having to continue to Co-sign because you are the Primary signed on all Loans.
Banks and Lenders are really tricky, so when they see that your child was co-signed on a loan, they automatically assume that you were the primary. They will be hesitant to approve a loan solely in your child's name and ask that you co-sign again. This can become a big issue and have you attached yourself to future loans for your child.
3 Most Effective Methods When Building Credit
There are a few ways to start building credit for your kids...
The MOST effective method is a secured credit card. The second best method is a Secured Installment Loan, and third is by adding them as an Authorized User to a credit card.
Let's explore all 3 methods....
1) Secured Credit Cards
The biggest myth our parents taught us is that credit cards are the worst things you can get. I couldn't possibly disagree with this statement more, but a POORLY managed credit card actually IS the worst thing.
Credit cards are a necessary evil, as the saying goes. You need credit cards to build credit and if you're looking to use credit to buy the things you want and need, then it's important to use credit cards as the "entry" into establishing good credit. Since building credit can be tough to do for your kids to do on their own, the best thing you can do is open up a Secured Credit Card for them.
Most secured credit cards still have a pre-approval process and most credit cards will deny your child one, so we recommend using two different credit cards that essentially guarantee them an Approval.
But what is a Secured Credit Card?
A Secured Credit Card is similar to a regular, run-of-the-mill credit card, in that you are issued a credit card once you've been approved. However, with a secured credit card, you will actually be borrowing against your own money. This means the card requires a refundable deposit before you can use it. You will determine the set "limit" by depositing the Amount you want the limit to be into the credit card account. Most secured credit card minimums are $200, but they will vary from card to card, so check the details.
Um, why would I borrow against myself?
Building credit is about healthy spending habits and your ability to pay off the credit card each month. Although the thought may seem silly, the impact it will have on your child's credit is MASSIVE!
Remember when applying for this credit card, it's going solely in your child's name, so IF you have the financial capabilities to apply for BOTH credit cards, do so.
Make sure your child has some type of income listed on the application, even if it's an allowance you give them. If you put $0 as their income, they will most likely be denied for any credit card they apply for, Secured or not.
Top 2 Secured Credit Card Recommendations:
The Credit Builder Card
In our opinion, The Credit Builder Card is the EASIEST card to apply for that has the FASTEST approval time!
Perks of the Credit Builder Card:
- Minimum Deposit of $200
- Reports to all three Credit Bureaus
- No Credit Check!
- No Credit Score Requirement
OpenSky Credit Card
Perks of the OpenSky Credit Card:
- Minimum Deposit of $200
- Reports to all three Credit Bureaus
- No Credit Check!
- No Credit Score Requirement
How to Use a Secured Credit Card
Using a Secured Credit Card is simple! When you get your credit card in the mail, you will make a small purchase (gas, a few groceries, etc.) and once you get your first bill, you want to pay the card off COMPLETELY.
It's also VERY important that you set up Auto Drafting from your bank if at all possible to make sure you never miss a payment.
Once you have made your first purchase, you will never have to use the card again AND your child will get credit for the payment history regardless if they purchase anything or not.
The reason making the first purchase is so important is because it is what OFFICIALLY opens up the card and is what allows it to start reporting to your credit.
2) Secured Installment Loan
This method is almost identical to opening a secured credit card, but instead it's a Secured Loan. The reason why a secured credit card is Recommended over a Secured Installment Loan is because Revolving Credit makes up the LARGEST percentage of your credit score (30-35%) in the beginning, so it will give you the best credit BOOST in the beginning.
Remember that having diversity in credit is just as important, so if you're financially capable, I recommend opening both a secured credit card and a Secured Installment Loan in your child's name.
How a Secured Installment Loan Works and Its Benefits
The Secured Installment Loan, unlike the secured credit card, actually provides your child with a savings account, so not only are they learning how to save along the way, but they get to see their money grow by collecting interest along the way.
Here's how it works...
Just like the Secured Credit Card, you would select the amount you want to set as your "limit"; the limit is usually $40.
Each month, you will receive a bill that you will pay, and they will report the payment history to your credit report. Once you make the payment, that amount goes into a savings account just for you!
Here's how the different Plans work:
Although you will be paying interest on your own money, the Pros SIGNIFICANTLY outweigh the Cons...
Always remember that in order to build credit, there's a small upfront cost. But it can't even compare to what it will cost IF you don't start to help your child build credit early!
3) Authorized User Account
The last Method that can help your child Build Credit is by adding them as an Authorized User to your credit card, otherwise called "Piggy Backing." This method ONLY works if you have a good standing credit card where your balance NEVER exceeds 30% of the overall limit.
How Being an Authorized User Works
When adding someone as an authorized user to a credit card, you are fundamentally allowing them to take credit for the Positive Payment History each month. This process will not affect you or your credit and is harmless and helpful to the Authorized User. This process can only become destructive IF you issue them a credit card they can use. I recommend you do NOT do this, even if you fully trust your child. It can create bad spending habits and can impact your own credit health. Although most lenders do not look at authorized user accounts as having any credibility on a credit application, it still can help your child boost their scores. This will help them start to build up their credit history, which DOES play a role towards their overall Credit Score.
How to Add your Child as an Authorized User
This process is super simple!
Some credit card companies will require your child be at least 18 years old, but this isn't true for most credit credit cards...
You can easily add them by calling your card's customer service line OR logging into your online account and looking for an option to add them as an Authorized User. Usually they will only ask for their name, social security number, and ask you if you want to issue them a card. The process can take up to 30-35 days before it reports to your child's credit, but it's well worth the wait.
Once they are added as an Authorized User, you can just sit back and wait!
Make sure you ALWAYS make payments on time (preferably set up Automatic Payments) and keep the balance low.
IF, and ONLY if, you ever find yourself in a financial struggle and you run the risk of not being able to pay your credit card on time, IMMEDIATELY remove your child off the card to protect their Credit Score.
Remember you can always easily add them back, but if you have any derogatory remarks hit that credit card account while their name is on it, it will negatively affect their credit too.
It's crazy that these things were never taught to us by our parents, school, or even financial advisor...its such an EASY way to set up our kids for financial success!
What's even crazier is that this process can tremendously help remove the responsibility of parents being financially tied to their children for 10-20 years AFTER leaving the nest...
Our goal as parents should always be to set up our children to be Financially Independent with healthy credit, and this is one REALLY BIG STEP in that direction.
If you found value within this article, share it with anyone you think will benefit from the knowledge. As always, leave comments below with your thoughts and any questions you might have.
Have a healthy credit day!