How to Build Your Kid's Credit Score
I purchased my first home when I was 22. I didn’t have enough cash to pay the entire down payment, but my lender didn’t mind because my credit score was already high enough to convince them I could handle more debt. This was made possible due to my parents’ insistence that I start using a credit card as soon as I turned 18. I didn’t know how useful building credit would be at the time, but I certainly understand now. This begs the question: At what age can someone begin building credit? And what are some ways to do it?
How Credit Scores Are Built
To build credit, you must prove you can pay off your debts on time and consistently over a long period while maintaining a low borrowing rate. Let’s break this down:
1. Credit bureaus
The 3 main credit bureaus track people’s credit history and are allowed to begin tracking credit history once an individual turns 18. However, a credit score only becomes available about 3-6 months after they open their first account. For example, if one opens their first credit account, let’s say a credit card, at 21, this is when they start building credit. On the other hand, if you somehow manage to have a credit card before 18 (more on this later), the length of time you held that card open will be reported once you turn 18. The latter example is exactly the situation we want, so we give our children a head start in the financial world.
2. Age of credit accounts
If one frequently opens and closes credit cards, for example, the age of your credit accounts will be very low. This is a red flag in the eyes of the credit bureaus, thereby lowering your credit score. Thus, keeping multiple credit accounts open over many years will boost your credit score.
3. Credit utilization
Credit utilization is the percentage of your maximum credit used. For example, having a $5,000 balance for a loan with a $25,000 credit limit would mean a 20% credit utilization rate. Maintaining a low credit utilization rate is positive for your credit score. It’s unclear what the ideal ratio is, but many say keeping your credit utilization ratio between 10-30% is a good target range. Thinking back to fractions, there are 2 ways to keep a percentage low: reduce the numerator (number above the line) or increase the denominator (number below the line). In finance, the numerator is your loan balance, and the denominator is your credit limit. Therefore, you can use less of your credit, increase your credit limit, or both to reduce your credit utilization rate.
4. Number of loan applications
Most loan applications require a hard credit inquiry, which is when a lender pulls your credit report from one of the credit bureaus. A hard credit inquiry will stay on your report for 2 years, but only negatively affect your score for 1 year. Thus, if you continually apply for loans in rapid succession, each hard credit inquiry will continue to damage your credit score in the short term. In the eyes of the bureaus and, therefore, your potential lenders, having to apply for multiple loans in the short term indicates that something is amiss financially. All in all, the goal is to apply for loans only when necessary. You should be confident that you will be approved for the loan before applying, and plan to utilize the debt responsibly for a lengthy time.
5. Variety of credit
Demonstrating that you can manage multiple types of debts is a positive skill. The credit bureaus agree and, therefore, reward us with higher credit scores when we do this. Without getting into too much detail, an example of a diverse set of debts would be credit cards, an auto loan, a mortgage, and utility bills.
6. Payments
Missing a debt payment is a surefire way of damaging your credit score. Therefore, paying your debts consistently and on time will yield a higher credit score. One of the biggest mistakes people make is when they only pay their minimum balances. While paying the minimum balance won’t directly damage your credit score, it will indirectly affect it because you will carry your leftover balance from one month to the next. In turn, this will:
Make it more difficult to pay off the entire statement balance the following month
Accrue interest on the balance
Increase your credit utilization rate: Carrying a higher balance will drive it upwards.
Ways to Build Your Child’s Credit
We need to give our children access to debt to help them build credit early. Let’s discuss several ways to do this.
1. Credit cards
The primary barriers to entry are age, credit history, and income requirements for credit cards. There are many types of credit cards, but for the sake of this topic, I will only focus on 3 types:
Regular credit cards
Age requirement: 18 or older
Credit usage reported to credit bureaus: Yes
Income checked by lender: Yes. Adding yourself as a co-signer on the card can help overcome this requirement. The co-signer is held financially responsible for payments if the primary cardholder does not, which reduces lenders’ risk.
Credit checked by lender: Yes
Student credit cards
Age requirement: 18 or older
Credit usage reported to credit bureaus: Yes
Income checked by lender: Yes, but they have lower income requirements than regular credit cards. You may add yourself as a co-signer to overcome this requirement.
Credit checked by lender: Little to no credit history required.
Authorized users
Age requirement: Varies between lenders. Some don’t have any minimum age requirements.
Credit usage reported to credit bureaus: Varies between lenders. You need to verify with your lender before applying for the card. If the lender doesn’t report the card’s credit history to the credit bureaus, they won’t build credit.
Income checked by lender: No. The primary cardholder is solely responsible for bills, not the authorized user.
Credit checked by lender: No.
An authorized user is when you add another person to your credit card, granting them a separate card but attaching them to your card’s credit history. Between the 3 types of credit cards, only the authorized user option allows us to build our children’s credit scores before 18. Technically, minors won’t have a credit score until 18, but adding them as an authorized user to your credit card(s) sooner will increase the length of credit history that will be reported to the credit bureaus once they turn 18.
Lastly, authorized users will likely get a boost to their credit score because adding them to your credit card will provide access to a higher credit limit than they would qualify on their own, thereby reducing their credit utilization rate.
2. Loans
Installment loans require monthly payments, like auto, mortgage, or student loans. Acquiring one will diversify the types of debts your child has in their credit history. An auto loan or mortgage might be difficult to qualify for early on, but you can add yourself as a co-signer on your child’s loan to help them overcome qualification hurdles. Student loans are the easiest installment loan they’d be able to qualify for on their own.
3. Report additional credit activity
Make sure that your children’s credit activity is actually getting reported to the credit bureaus. For example, most of the time, paying for utilities, phone bills, and rent aren’t usually reported to them. However, you can use a third-party company to report them for you or sign up for special programs, like Experian Boost, to accomplish this. Doing so will further boost their credit scores.
Conclusion
I should note that I didn’t get into how to teach our kids how to use debt like credit cards, nor did I talk about the dangers of handing a credit card to a child. They obviously need to be mature, responsible, and have good role models before they enter the world of debt. Our education system fails to teach the life skill of money management, including handling debt, so teaching them is your responsibility is their parent.
In summary, to help boost our children’s credit scores as early as possible, adding them as authorized users to multiple credit cards, co-signing their loans, and reporting credit activity like paying utility bills to credit bureaus are all great ways to give them a boost in the world of credit scores and debt.
Do you wish you had done something differently with debt when you were younger that would’ve helped you (or your credit score) later in life? Help the community learn from your experiences, and share below!
