If you've got a recent high school graduate who's getting ready to head off to college or join the workforce, let me share a few lessons I learned the hard way about managing personal finances that you can pass along to your kids.
Young adults are just starting to build their credit history. In the coming months they'll probably encounter many unfamiliar expenses -- and many financial temptations. If they're not careful, a few ill-thought decisions made now could damage their credit for years to come.Among other things, a poor credit score can:
- Make it harder to qualify for loans. Even if they do somehow qualify, they'll probably pay much higher interest rates.
- Raise their insurance rates.
- Disqualify them for certain jobs.
- Make it harder to rent an apartment.
Here are several actions your kids can take to build good financial habits and strong credit -- and a few minefields to watch out for:
Probably the most fundamental tool for young adults to help manage their finances is a basic checking account and debit card. A few tips to pass along:
- Look for a bank or credit union that charges no monthly usage fee, doesn't require minimum balances and has conveniently located ATMs so you don't rack up out-of-network ATM charges.
- Enter all transactions in the check register, a simple computer spreadsheet or use a digital tool like Mint.com and review your account online regularly to know when deposits, checks, purchases and automatic payments have cleared.
- Don't write checks or make debit card purchases unless the current balance will cover them -- many transactions now clear instantaneously.
- Banks are required to ask whether you want overdraft protection for transactions that would cause you to overdraw your account (versus simply declining the transaction and/or charging you for a bounced check). If you opt for coverage, understand that overdrafts can be expensive -- up to $35 or more per transaction.
- Request text or email alerts when your balance drops below a certain level, checks or deposits clear, or payments are due.
Credit cards for young adults can be a useful tool, but they must be used responsibly. By law, 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.Although this policy probably prevents many young adults from amassing credit card debt they cannot afford, it may also make it more difficult for them to begin building a credit history. Parents can help out in a few ways:
- Make your kid 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, any account activity, good or bad, goes on both your credit reports, so careful monitoring is critical. Make sure they don't make late payments or exceed the credit limit; otherwise your own credit score could be damaged.
Another way to build credit history is to start out with a "secured" credit card -- a card linked to an account into which you deposit money. (Regular credit cards are considered "unsecured" because they aren't tied to underlying collateral that can be seized in case of non-payment.) Typically users can charge up to the amount they've deposited and then replenish the account with more funds.
After they've made several on-time payments, have your kid ask the lender to convert it to an unsecured card, or to at least add an unsecured amount to the account. Just make sure that the lender agrees to report your payment history to at least one of the three credit bureaus; otherwise, the account does nothing to improve your credit.If they do qualify for an unsecured credit card, have your kids follow these guidelines so they don't start off on the wrong foot:
- Always make at least the minimum payment -- on time -- each month.
- Strive to pay off the full balance each month; otherwise, the accumulated interest will add significantly to your repayment amount.
- Avoid using credit cards for cash advances, which often incur upfront fees and begin accruing interest immediately.
- Try never to owe more than 30 percent of your credit limit on any card.
- If the card has a low introductory interest rate, make sure you understand if and when it will increase and to how much.
- Look for a card with no annual fee and also compare cash advance, late payment, balance transfer, over-the-limit and other fees. A good place to comparison shop is Bankrate.com.
To learn more about building and maintaining strong credit, visit What's My Score, a financial literacy program for young adults run by my employer, Visa Inc., which features a free, comprehensive workbook called Money 101: A Crash Course in Better Money Management. Also, check out my previous blogs, Understanding Credit Scores, and Improving Your Credit Score.
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.