Unfortunately, credit has more than a few things in common with the highly addictive street drug. Both are readily available and seem cheap at first. But both can lead to a spiral of financial devastation and emotional despair.
Unlike cocaine, though, credit is pretty much a necessity in the modern world. A good credit rating will make it easier for your children to rent their first apartments, land good jobs, get better rates on their insurance coverage and buy homes.
So knowing how to handle credit is important, but its not something your kids are likely to learn in school. Few schools, public or private, include personal finance instruction as part of their curricula.
My kids went to a top private high school in San Francisco, and they were never taught about money, said Judith Gilson, a University of San Francisco education professor whose three children are now in their 20s. Kids learn by default, or they learn from their parents.
Parents who have raised money-smart kids say this instruction is not something you can put off until college. Consider the statistics:
- One out of three high school seniors uses credit cards, and half of those have cards in their own names, according to a survey conducted earlier this year by the Jumpstart Coalition, which promotes financial literacy.
- 78% of college students have credit cards, according to student loan maker Nellie Mae, and the typical student carries a balance of $3,200. One out of 10 college students carries a balance of more than $7,800.
- The proportion of bankruptcy filers under 25 has risen from under 1% in 1995 to more than 5%.
So how to begin? Heres a step-by-step guide.
- Middle school
At this age, most kids are ready for more abstract concepts. Parents can begin talking about compound interest -- how it works for you when youre saving money, and works against you when you borrow.
Children are usually ready to take on more responsibility for budgeting and spending at this age, as well. Ronalyn Huenergard of Seattle gave her two daughters a certain amount of money to buy school clothes each year, starting in middle school. They could spend the money as they chose, or save a portion to buy something later. Understanding spending limits is an important step in learning how to control credit spending, Huenergard said.
When it was gone, they were done, Huenergard said. They both have done well with this approach and I found it helped my budget a lot too.
Of course, parents should be modeling these behaviors in their own lives as well.
- High school
Nothing teaches money management like actually managing money, so its probably time to help your child open a checking account, if you didnt do so in middle school. Learning how to write checks, reconcile a bank statement, avoid overdrafts and deal with bank fees are all important lessons in money management.
Once your teenager has the hang of a bank account, consider adding plastic to the mix.
Here are your options:
A debit card. Debit cards, which have a MasterCard or Visa logo, allow the child to make withdrawals at ATMs, but also can be used like credit cards. The difference is that the charge is deducted directly from an account's balance.
This training wheels approach allows your child to practice with plastic while limiting the potential damage. Huenergard said her elder daughter, now a sophomore, proved so responsible at handling her debit card that Huenergard wasnt worried about her ability to handle a credit card.
She managed that (debit) card very well -- no notices of overdrawn accounts and such, Huenergard said.
A prepaid credit card. Prepaid cards like Visa Buxx or Citibanks Citi Cash Card allow parents to set spending limits and monitor where their children are spending money, both through monthly statements and through Internet accounts that show daily transactions. The parents transfer money from their own checking accounts to the card for a small transaction fee, and the card can be used like any other credit card to make purchases.
Parents can see how their kids are spending the money and hopefully have discussions with them, said Dara Duguay, Jumpstarts executive director.
A low-limit credit card. Some parents opt to help their child apply for a real credit card, co-signing for an account with a $200 to $300 limit. (This approach is generally preferable to adding a child to one of your own accounts, since teenagers lose things and you dont want to deal with a thiefs charges on your own high-limit account.)
Nan Mead of Greenwood Village, Colo., got her son one of these tightly restricted cards while he was a high school senior, so she could review his spending and talk about smart money management -- a discussion that started when the boy was in middle school.
With a lot of the groundwork already having been laid, I was comfortable with this decision to get him a card, said Mead, director of communications for National Endowment for Financial Education, whose son is now a sophomore in college.
If your student has learned credit basics, now is the time to encourage -- yes, encourage -- her to apply for a credit card in her own name, without your co-signature. Credit is actually harder to establish once a student graduates, Duguay said, probably because lenders realize that graduates are less likely to be bailed out by their parents.
Patty Mayeux of Houston was adamant that her daughters, now 19 and 22, start building a good credit history -- by applying for credit sparingly, paying off their bills on time and not carrying a balance.
I come from the generation where a lot of women never developed a credit history. When something happened to the husband or the marriage, they didnt have incomes and didnt have credit, Mayeux said. Everybody needs to develop a good credit history.
Those seductive minimum payments
In addition to basic money management skills, parents should emphasize the importance of a good credit rating and the need to pay bills on time. Teens should also understand how seductive, but expensive, it can be to make only minimum payments on credit cards and other loans.
Teenagers need to know that a $1,000 credit card balance can take 12 years to pay off if they only make the minimum required payments, which are typically just 2.5% of the balance, Duguay said. The total interest cost over those 12 years? $979. Just adding $25 to the monthly payment can shave the payoff time to two years, seven months, Duguay said, and the interest cost to $223.
Even better, of course, is to teach your children not to charge more than they can pay each month.
What if Junior needs a bailout?
What should you do if your child does get in over her head? Parents differ in their approaches.
Huenergard of Seattle made it clear when her elder daughter applied for a credit card earlier this year that the charges were her daughters responsibility. I do believe she is using it responsibly, as she knows that her parents won't bail her out, Huenergard said.
By contrast, Cindy Griffin of Sturgis, S.D., wants a chance to intervene should her son, Nick, encounter trouble. Many parents worry that their children might hide credit problems from them, leading to late payments and black marks on their credit that can last for years. We've discussed credit cards for a couple of years and how people get into trouble with them, Griffin said. We have also discussed that if he runs into a problem with payments that he should let me know before the payment is due so we can give him a hand.
Whatever your decision, your role as teacher still hasnt ended.
Safe debt levels
College is the time, Jumpstarts Duguay said, to talk about safe debt levels. After graduation, your child probably will face other debt obligations, such as student loans. He may also be tempted to borrow to buy a car, furnish an apartment or finance an end-of-college trip.
[College students] should know that no more than 20% of their net, after-tax income should go for all your (non-mortgage) debt payments, Duguay said. If they have student loans and a car payment, thats pretty much it -- they cant afford to have any revolving credit at all.
If youre feeling a bit uncertain about your ability to teach your children what they need to know, take heart. There are plenty of resources available. Jumpstart has training materials for all ages, as does the National Endowment for Financial Education. In addition, Wells Fargo Bank has developed a three-part interactive Web series called Banking on Our Future that you and your child can find (see links at left).
Who knows? Maybe youll learn a thing or two yourself.
What Every Preteen, Teenager and Young Adult Needs to Know to Avoid Credit Card Debt
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