All parents want to ensure their children have every opportunity to succeed in life. Teaching teens how to build credit positions them to take advantage of lending opportunities as young adults. Unfortunately, people between 18 and 25 years old, identified as Generation Z, have the lowest average credit scores of any demographic at 679. But by better understanding why establishing creditworthiness early is important and taking the steps to acquire a good FICO score, your child could enjoy greater financial success.
Why Credit Matters
Having good or poor credit impacts many aspects of our daily lives. The FICO scores generated by Equifax, Experian, and TransUnion are often considered when someone completes a job application, rents an apartment, or needs a car loan. In a competitive job and housing market, that three-digit number can either put you at the front of the line or leave you holding the door for others. That’s why the importance of earning a good FICO score cannot be understated.
Factors That Affect Credit
The three major credit bureaus use an impartial measuring system that weighs various aspects of credit usage and fiscal responsibility. Each of the following metrics raises or lowers a percentage of your FICO score.
- Repayment History: Considered a primary measurement of creditworthiness, it accounts for 35 percent of a FICO score. A single missed payment can negatively impact a score.
- Credit Utilization: The ratio of outstanding debt versus total borrowing bandwidth accounts for 30 percent of a FICO score. To build credit, keeping a maximum 30-70 ratio is advisable.
- Credit History: How long someone maintains a credit card or other borrowing options makes up 15 percent of their score. That’s why canceling credit cards isn't always a good idea.
- Credit Mix: A diverse portfolio of credit cards, personal loans, and other loans affects 10 percent of your score. The reasoning is that diversity is an indicator of good money management practices.
New credit also influences a FICO score by 10 percent. Although applying for a student credit card or adding a child to one of yours may result in a short-term credit score dip, the number typically bounces back quickly.
5 Steps for Understanding How to Build Credit
Although the minimum age to obtain a credit card or an official FICO score is 18, parents can begin to lay the groundwork for their young teens. By taking the following steps to understand how to build credit, your child could get a head start right now.
1. Start Teaching the Important Principles Early
There are painless ways that parents can help their children build credit during their teenage years. Impress upon them the importance of always paying bills on time (if not earlier) and in full. If they're able, advise them to pay more than the minimum payment to help eliminate the bill faster, leaving them more money to pay for other things. Teach them to be thrifty with their funds by showing them how to spend less than they earn. It also helps to explain how FICO scores are calculated and the benefits of having good credit.
2. Teach the Difference Between a Debit Card and a Credit Card
When your child looks at the plastic card used to pay for dinner or groceries, nothing actually distinguishes a debit card from a credit card. It’s essential to educate teens about the fact that debit cards pull money directly from a checking account, while a credit card is borrowing money that you must pay back. Consider showing your child a monthly account statement as a visual example of how debit cards lower cash balances (liquidity) and credit cards create monthly charges that trigger interest (liability).
3. Incentivize Saving
Most adults opt-in to work for companies that match 401(k) deposits. This type of incentive tends to motivate employees to invest more heavily in their retirement fund. That same psychology can be used by parents with their children by matching a deposit into a savings account based on the amount of money their child saves every month. This incentive helps teach them the value of saving versus spending and inspires children to save money.
4. Add Your Child as an Authorized User
To get a credit card of their own, your child needs to be 18 and have a steady source of income. If your child is under the age of 18 you may be able to add them as an authorized user to one of your credit cards. This allows them to make purchases as a start to building their credit but only to some degree. Because the primary cardholder is responsible and liable for making on-time payments, the FICO scores of secondary users are less affected. But the strategy to help build credit will show up on the credit bureaus’ radar.
5. Report all Possible Forms of Credit
In terms of influencing the metric that calculates the length of accounts, reporting all types of credit usage can prove beneficial. When your child reaches the age of 18, consider helping them secure credit in their own name with a Peach State Student Platinum with Rewards Visa Credit Card, by opening a secured loan or another credit reporting account (such as a cell phone), and making sure all financial data is being reported.
Get Your Child Started on Their Credit Building Journey with Peach State Today
Peach State is here to help your young family members get started on their credit building and financial journey. With a Peach State FCU eXtreme Teen Checking Account your young savers will have a place to deposit their money while learning practical money management skills. If you have any questions please feel free to contact Peach State today!