By Ali Kahil, Tax & Financial Analyst; and Rachel Gil, Associate Director of Governance and Education at Cresset.
Many young adults graduate high school or college without understanding how credit works or the importance of having a good credit score. Establishing good credit is not just about getting approved for a credit card. Credit scores impact applications for loans, rental properties, and even landing a job.
If you have a teen or young adult in your life, you can give them the gift of starting their credit journey early. A gift that — when managed well — can have a lasting impact throughout one’s life.
When I (Ali) was 17 years old, my mother added me as an authorized user on her credit card. At age 20, when I finally decided to apply for credit under my own name, I had a 750 credit score and was approved for a higher limit without any employment or prior personal use of credit. This was one of the most impactful gifts I received as a young adult, as I was able to skip the “credit-building” stage of my credit score journey. Every car, student, or personal loan and subsequent credit card has offered me some of the lowest interest rates with the highest dollar limits and loan amounts.
In my case, my mother’s credit score did not become my own. Rather, the perfect payment history, the credit limit size, and the length of time in which that credit card had been established reflected on my credit report. I am now in my late 20s, but my credit history goes back more than a decade.
Similar results can be achieved by adding a young adult to a loan with a limited duration. That can include a car lease or a personal loan. However, there are several important caveats to remember. Not every credit card issuer will report authorized users to the credit bureaus. In addition, there may be age restrictions on adding an authorized user.
Credit bureaus also constantly adjust how credit scores are calculated. Each loan or credit card underwriting process is unique and may disregard or underweight an authorized user’s history on a borrower’s credit file. In addition, if you have had previous credit card payment issues, that can reflect on your child’s credit report. If so, you may want to skip this advice all together.
Talk to the issuer of your credit card to learn about their policies and procedures on how they report authorized users to each credit bureau. Ask how they consider new applicants when their credit history is limited to just being an authorized user.
Preparing a Young Person to Be a Good Steward of Credit
Every family and financial situation is different. There may very well be reasons why adding your child as an authorized user to your account does not make sense or makes you feel uncomfortable. Perhaps you are worried that your child is not ready for the responsibility of a credit card and may get in over his / her head. Perhaps your credit score isn’t as high as you would like, and you’re worried that it may impact your child’s score. Whatever the reason, there are other ways your child can begin building his or her credit:
- Use a Separate Credit Card with a Lower Credit Limit. If you like the idea of adding your child as an authorized user, but you worry about him or her having access to your full line of credit, you can consider opening a separate credit card exclusively for your child to use as an authorized user. Once you apply and are approved, you can request that the card issuer lower the credit limit to an amount you are comfortable with.
- Request a Secured Credit Card. If your child is 18 or older, a secured credit card may be a helpful way for them to begin establishing credit. Secured credit cards require a deposit, and that deposit becomes the card’s credit limit. For example, if a secured card requires a $500 deposit, the maximum amount a user can charge to the card is $500. Typically, the deposit is refunded to the user when the account is closed or converted to an unsecured card, assuming the balance has been paid in full.
- Apply for a Credit-Building Loan. A credit-building loan is another tool that may be used to establish or enhance credit. With a credit-building loan, the lender holds the borrowed amount in an account while the borrower makes payments toward the loan. Once the loan is fully paid off, the borrowed amount (sometimes with earned interest) is released to the borrower. You can consider the loan payments as contributing to savings with the added benefit of building a credit history.
When it comes to building credit, the most important factor is ensuring that payments are made in full and on time each month. If your child cannot handle this responsibility, it is probably best to wait on any of the aforementioned credit tools. Remember, pulling out of debt and bad credit is more challenging than having no credit at all.
