July 21, 2016
Young adults are making a big mistake with their finances. Survey after survey reports that most millennials do not have a credit card. I am wholeheartedly on board with preferring a debit card. But everyone needs to also have a credit card and use it responsibly.
One of the most important tools you can have in your financial tool kit is a strong FICO credit score. You can be the most responsible debit-card user on the planet and it will do nothing to help you build a credit score. As absurd as it is—and yes, I do think it is absurd-one of the best ways to build a credit score is to use a credit card. The three major credit bureaus all factor in your credit card payment track record-do you pay on time?-into their FICO credit scores. And how much of your available credit that you use in any given month is another important factor in determining a FICO score.
Of course, without some solid guidance, a young adult can make a mess of his or her financial life by running up way too much credit card debt. So my dear parents, your job before a child moves out is to make sure they have aced smart credit card habits:
Add a young teen to your card. A child can be added to an existing credit card account as an authorized user. Consider this the training wheels step. Have your child use the card once in a while for an agreed-upon-expense. And then make it a ritual to sit down and go over the credit card statement every month, spending some time explaining the trap of just paying the minimum balance due.
When a child is added as an authorized user, they will begin to build a credit profile based on your account. That can be a great help if you in fact have a high FICO score. But keep in mind that a new version of FICO scores differentiates between someone having their own account and someone being an authorized user. Authorized usage gets less weight in the FICO scoring system. This new scoring system isn’t yet widely used, but it’s something to keep in mind. Sooner than later you probably want to consider graduating your child to their own credit card.
Co-sign a Regular Credit Card, or a Secured Card. Minors who don’t have ongoing income can only get a credit card if an adult co-signs. A no-fee credit card with a very low credit limit can be a smart way to help a high schooler build a credit profile based on their own record (rather than as an authorized user on one of your cards.) But this requires care as well. The potential danger is that a safe initial credit limit of say $1,000 or so is suddenly increased by the card issuer (or your overzealous child asks for a higher limit) and some hefty charges are made. That can be an expensive lesson all around, as you are ultimately responsible for paying off all bills.
Another option is to have your child apply for a secured credit card. Secured cards require a deposit, and the user can only charge up to the amount of the security deposit. That’s a surefire way to stay out of over-spending trouble. Most secured cards report a user’s spending and payment habits to the credit bureaus, so they will indeed help a child build a solid credit file that will eventually translate into a good credit score. But it is smart to double check that any secured card you child applies for will indeed be reporting to a credit bureau. You can shop online for secured credit card deals. Many issuers charge an annual fee of $25 or so, but there are also deals with no annual fee. Shop around.
Teach the Golden Rule of Credit Card Management. Even if you carry an unpaid credit card balance from month to month, please don’t let your child think that is in fact the “best” practice. Teach your child that the smartest way to build a solid credit profile and retain financial freedom is to only make charges that they can always pay off in full each month. Developing this good habit from the get-go could be one of the most valuable financial lessons a parent can teach a child.
Answer Yes or No to the follow statements.
I pay all my credit card bills in full each month.
I have an eight-month emergency savings fund separate from my checking or other bank accounts.
The car I am driving was paid for with cash, or a loan that was no more than three years, and I sure didn’t lease!
I am contributing at least 10% of my gross salary to a retirement plan at work, or I am saving at least that much in an IRA and/or regular taxable account.
I have a long-term asset allocation plan for my retirement investments, and once a year I check to see if I need to do any rebalancing to stay on target with my allocation goals.
I have term life insurance to provide protection to those who are dependent on my income.
I have a will, a trust, an advance directive (living will), and have appointed someone to be my health care proxy.
So how did you do?
If you answered yes to every item, congratulations. If you are working on improving on a few items, I say congratulations as well.
As long as you are comitted to truly creating financial security, I applaud you. If that means you are paying down your credit card balances, or are building up your emergency fun with automated payments, that’s more than fine. You are on your way!
But if you found yourself saying No to any of those questions, and you’re not working on moving to Yes, then I want you to stand in your truth. No matter how good you feel, you have some work to do before you can honestly know what you are on solid financial ground.