Most parents make this money mistake, and it’s hurting their children’s financial independence
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It can be hard for young people to build credit, but some parents seem to think they have it figured out.
They often start by adding their teenager as an authorized user on their credit card. That can help children practice healthy credit habits when they’re young.
However, what’s considered a wise strategy is fraught with pitfalls, according to Erik Beguin, CEO of Austin Capital Bank and former member of the Consumer Financial Protection Bureau Community Bank Advisory Council.
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Children “piggybacking” on a parent’s credit history forgoes the opportunity for children to build their own credit profile, Beguin said. Since authorized users are not responsible for paying the credit card bill, those payments won’t show up on their credit report and contribute to their own payment history in the eyes of the credit bureaus.
Beguin recommends adding your child as a co-signer instead. That way, they take on the risk and reward that comes with being responsible for the bill.
Co-signing on credit cards can help your children build healthy credit while they’re young to ensure they won’t need to lean on you in the future, Derek Miser, a financial advisor and president of Miser Wealth Partners in Knoxville, Tennessee, also said.
However, in this case, you may be responsible for their debt if your child cannot pay it back.
Either way, “it’s important to use this as a steppingstone to establish credit in your own name,” said Ted Rossman, a senior industry analyst at CreditCards.com.
Rossman advises young adults to establish their own credit within six months or a year after piggybacking on their parent’s card, while they are still living at home but starting to be more independent. “It’s good to start early.”
A secured credit card is also designed to do just that. Often, secured cards require a cash deposit that then serves as the credit line, which can be a good fit for those without a proven payment history.
Why having good credit is so important
Young adults often don’t have a credit score, unless they already have a credit account.
Credit scores represent your credit risk and affect whether you can get a loan, as well as the interest you’ll pay. Generally, the higher your credit score, the better off you are.
FICO scores, the most popular scoring model, range between 300 and 850. A “good” score generally is above 670, a “very good” score is over 740 and anything above 800 is considered “exceptional.”
Once you reach that 800 threshold, you’re highly likely to be approved for a loan and can qualify for the lowest interest rate, according to Matt Schulz, LendingTree’s chief credit analyst.
Start with a conversation at home
Before families decide which credit card is best, “what’s really important is the conversation about how to manage your credit and responsible use of debt,” Beguin said. That largely boils down to paying your bills on time and keeping your credit-card balance low.
While there is an important role for schools to play, financial education should begin at home.
Those conversations could start well before the teenage years, most experts say. Too frequently, talking about finances is considered taboo, and that’s another mistake.
For more on cards for people with no credit history, check out CNBC Select’s recent ranking on the best credit cards to build credit.
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