Starting a conversation about building a good credit score with your child is essential in fostering responsible financial habits for their future.
Here are some key concepts to discuss with them.
What is credit?
Take the time to explain credit to your child – the process of acquiring something now by paying for it later – put simply, borrowing money. For instance, taking out a mobile phone contract is a form of credit – a service paid for over time. An overdraft facility is another example – a borrowing limit that can be used if there isn’t enough money to cover payments in a debit account. You can also talk to your child about applying for a student credit card, which tends to have a lower spending limit.
What is interest?
In simple terms, interest is the cost of borrowing money. It is a fee payable to the lender and is usually calculated as a percentage of the total or outstanding amount borrowed. However, it’s important to remember that interest rates for student credit cards tend to be higher than for regular credit cards.
What is creditworthiness?
Another critical concept to understand is creditworthiness, which measures how likely a person is to repay any money they borrow. The term ‘credit’ originally comes from Latin and means to ‘trust’, ‘entrust’ or ‘believe’. Your child can increase their creditworthiness (trustworthiness) by maintaining a good history of borrowing and repaying any money owed. This shows lenders that they are a reliable borrower.
After explaining these concepts, consider the following do’s and don’ts to help your child build a strong credit score:
Do’s:
- Open a bank account and set up a direct debit to begin building your credit score – but spend carefully and ensure you have enough funds to pay anything you owe.
- If you have a student credit card, use it responsibly to build your credit score, but not too much to jeopardise your creditworthiness – keep your credit usage to a maximum of 30% of your borrowing limit.
- Ensure you pay your monthly bills for rent, utilities and other services on time and in full; keeping up with direct debits and standing orders can help build your score.
- Discuss any big purchases you want to make with your parents and ask them about the best financing options.
Don’ts:
- Try not to go into your arranged overdraft if you have one; if you do, try to pay it off quickly and avoid going into it as much as possible, as you may be charged interest.
- Avoid spending too much – you may be left short at the end of the month, unable to pay a bill or forced to go into overdraft.
- Prevent mounting debt and unpaid bills from piling up – this can make debts more expensive to repay and make it harder to borrow in the future.
- Ask someone for support if overdrafts or student credit cards become a problem. There are charities available that can help young people manage debt.
Good credit management is essential for your child’s future, and they should learn the benefits of developing financial discipline to achieve their goals. This will help keep them financially stable, which is essential for accessing credit further down the line for life milestones like buying a car or a house, starting a family and planning for retirement.
Use this guide to help explain to your child that building a strong credit reputation as early as possible and learning to make responsible financial decisions is important for their future well-being.