With the US facing its worst recession in 30 years, many are being reminded of the importance of financial literacy. In fact, many are debating whether it’s important enough to make it a requirement in our school systems.
Increasing the importance of financial literacy is new legislation that takes effect in February 2010 which prohibits anyone under the age of 21 from obtaining a credit card unless a parent, guardian or spouse is willing to co-sign. The one loophole to this is if you can prove you have sufficient income to cover your credit obligations, you may be approved.
There are several statistics that show the need for increasing the age limit on a credit card. According to a 2009 study by Sallie Mae:
- In this time of economic downturn, college students are relying on credit cards more than ever before with the average amount of debt increasing 46% since 2004.
- Half of college students have four or more cards and seem to use them to live beyond their means. Close to one-fifth of seniors carries balance greater than $7,000.
- Nine in ten graduates paying for direct education expenses with credit cards and the average college graduate owes about $19,000 in student loan debt.
- One-third of students rarely or never discussed credit card use with parents, and nearly all undergraduates would like more information on money management topics.
If those under the age of 21 can no longer apply for a credit card, it may reduce debt for some college students who are depending on credit cards, but what about those who want to become independent? How can they build a good credit history so they can ultimately rent an apartment or buy a car, when they can’t qualify for credit?
This is where the importance of financial literacy becomes even greater, as young adults will not only need to start building credit early but they’ll need to learn how to build their credit without actually having a credit card.
Here are 5 ways for parents to steer their teens toward financial responsibility and help them build credit:
- Start safe. Open up a checking account with a debit card. Depositing birthday and Christmas money into a savings account helps teach kids about savings at a young age, but once your child starts working or receiving an allowance, they should start learning about budgeting and the responsibilities of paying bills. Opening up a checking account and letting them have a debit card is a great way to start. While a checking and savings account do not begin your credit file, they will be checked as evidence that you have money and know how to manage it. Checks can be used to show that you pay bills regularly, a sign of reliability.
- Make your teen an authorized user on your credit card. There are two approaches to this idea. First, you can make your teen an authorized user and not give them an actual card to use. Just having their name on the account will help build credit. The alternative is to actually give them a credit card for use. While it can be scary, I’m actually a fan of this approach, as I think it’s important to give the responsibility to your teen. Show them how to read a credit card statement, what they should watch out for on statements and make sure bills are paid on time. Letting them go through the process is giving them the true experience of financial management. Of course the idea of making your teen an authorized user is only a good idea if you have a good credit!
- Open a joint credit cardYour teen can still get a credit card under the age of 21 if you co-sign on the card for them. If you believe your teen is ready to handle the responsibility of a credit card, than this is a great option. Be sure to talk with them about how joint accounts work and if necessary, set limits or expectations on the use of the card. LaToya Irby at About.com has some great tips for sharing a credit card.
- Open a secured credit cardA secured credit card is a card which requires the user to provide a cash collateral deposit that then becomes the credit line for that account. There are a lot of pluses and minuses to getting this type of credit card, but it is a good way for people who have no credit to build up credit. Throughout time you can add a cash deposit to give yourself more credit, or sometimes the bank will reward you for good payment and add to your credit line.
Bankrate.com has an article on 10 questions to ask before getting a secured credit card, which is a great read if you are thinking about this option.
- Get your child a prepaid debit cardThis is a relatively new type of card that enables parents to issue a debit card for their teen, but with built-in parental controls. The card gives parents several options including setting spending limits, receiving alerts and restricting certain shopping categories (i.e. tobacco or liquor). One thing to be cautious of is the membership fee, as these cards tend to have a sign on fee plus annual membership costs.
While it seems a little overbearing to me, it is a good way to start before diving into a full on credit card. The card will not actually help build credit, but it will help teach your teen about managing money and spending within their means. Some cards do offer special programs designed to help people with no credit or with damaged credit build positive credit history. More information on prepaid debit cards can be found here.