To parents with a freshman entering college this fall: You're probably expecting to shell out major bucks for tuition, room and board and a million other necessities over the next few years. But before you send your kid off, make sure you share one gift likely to steer him or her along the road to financial security -- a sound understanding of how credit works.
You probably learned the hard way yourself that young adults encounter many unfamiliar expenses -- and temptations -- upon entering college or the workforce. So it's important to help your kids avoid early financial missteps that could damage their credit for years to come. A poor credit score can impact their ability to qualify for loans, get favorable interest and insurance rates or even score a job or apartment.
Checking account. The first step in managing personal finances is mastering the basic checking account and debit card. Here are a few tips you can pass along:
- Look for a bank or credit union that charges no monthly usage fee, requires no minimum balance and has conveniently located ATMs so you don't rack up foreign ATM charges.
- Enter all transactions in a check register or in a budgeting tool like Mint.com, and review your account online at least weekly to verify when deposits, checks, purchases and automatic payments have cleared.
- Avoid writing checks or making debit card transactions unless your current balance will cover them -- such transactions often clear instantly.
- Banks must ask whether you want to opt-in for overdraft protection (where they'll cover an ATM or debit card transaction if you have insufficient funds in your account). Before opting in, realize that overdrafts can be expensive -- up to $30 or more per transaction.
- Alternatively, ask whether the bank will link your checking account to a savings or other account to avoid overdraft charges.
- Ask for free text or email alerts when your balance drops below a certain level, checks or deposits clear or payments are due.
Credit cards. A good way to build sound credit is to demonstrate responsible credit card use. Because many young adults were getting in over their heads because of too-easy access to credit, the 2009 Credit CARD Act established that people under age 21 must have a parent or other responsible adult cosign credit card accounts unless they can prove sufficient income to repay the debt.
So how can parents help their kids begin building a credit history if they can't open their own account? A couple of alternatives:
- Make them an authorized user on one of your accounts. They'll get their own card and you can usually restrict the amount they're able to charge. Authorized users are not legally responsible to pay balances owed -- that's your responsibility, so tread carefully.
- You can add them as a joint account holder to a new or existing account -- preferably, one with a small credit limit. Joint account holders are equally liable to pay off the account.
- Just remember that with both these alternatives, any account activity, good or bad, goes on both your credit reports, so careful account monitoring is critical. Make sure they don't make late payments or exceed the credit limit; otherwise your own credit score could be damaged.
Secured cards. If your kids haven't yet demonstrated financial maturity in other areas (e.g., maintaining a balanced checking account), they may not be ready for an unsecured credit card or loan. You might consider getting a secured credit card, which is linked to an account with the card issuer to which they deposit money.
Typically, users can charge up to the amount deposited to open the account. Purchases are charged against the account's revolving credit limit. As they pay off the balance, their available credit goes up again, just like a regular credit card. Then, after a period of on-time payments, they can ask the lender to convert it to an unsecured card, or to at least add an unsecured amount to the account. Just make sure the lender reports payment history to all three credit bureaus, so your kid can start building credit history.
Prepaid cards are another good tool to teach young adults how to manage their finances. They look and work much like regular debit cards except that instead of being funded through a checking account, you preload money onto the card, which your kid then uses for purchases or ATM withdrawals. Once the balance is used up you can reload the card -- kind of like paying an allowance.
You can monitor account activity online or by phone. As with secured credit cards, fees and restrictions may apply so shop around for the best terms. Although prepaid cards are a good money-management tool, they generally don't help build credit history. Bankrate.com has rate comparison tools for both secured cards and prepaid cards.
If you need help educating your kids about personal financial management, a good resource is What's My Score, a financial literacy program for young adults run by my employer, Visa Inc. Among other tools, it features an interactive Credit 101 tutorial and a comprehensive workbook called Money 101: A Crash Course in Better Money Management, which can be downloaded for free. Also, check out my previous blogs, Demystifying Credit Scores, A New Breed of Prepaid Cards and The 411 on Prepaid Cards.
Bottom line: Getting your kids off on the right foot, credit-wise, can make all the difference to their future financial health.
This article is intended to provide general information and should not be considered legal, tax or financial advice. It's always a good idea to consult a legal, tax or financial advisor for specific information on how certain laws apply to you and about your individual financial situation.