You’ve done everything right as parents. You read all the books on raising financially fit children and started talking to your kids about money and wealth from an early age. You helped them open their first saving accounts, then checking accounts, and even made them authorized users on your American Express account when they went off to college. Now you are shaking your head in disbelief as your financially literate and responsible daughter has just been turned down for her first mortgage. How could this happen in your family?
The truth is that building up your creditworthiness is not as easy as it may seem. According to mortgage broker Dave M. Damaré, founder of the David M. Damaré Team in Raleigh, North Carolina, it takes more than a good credit score. “The majority of young adults I speak with have no credit history and many of the rest have thin credit.” Thin credit is a term used in the lending industry to describe a borrower who has a thin file as a result of having very little credit history. The result is that Damaré and other lenders often have to look these young borrowers (and their parents) in the eye and tell them their loan is denied—or that they’ll need to do some work to establish their credit.
How can you help your son or daughter avoid this fate? There are a number of ways you can help ensure your children’s credit will be ready when they need it.
When it comes to establishing a track record with the credit bureaus, it’s important to start early. Begin the process when your child is a sophomore or junior in college, if not sooner. Why? Because the credit bureaus look for a history of a minimum of 12 to 24 months of using established credit responsibly when evaluating your child’s ability to repay. If your daughter wants to attain a mortgage to buy her first home upon graduation, being proactive while she is still in college will help her credit look more attractive to a lender and increase her chances of success.
LOOK BEHIND THE CURTAIN
There are certain rules in the lending industry that many consumers and well-intended parents aren’t aware of. The most important one is the idea that all credit is not created equally. In other words, a retail charge card is not viewed the same by a credit bureau as a bank-issued Visa. Meanwhile, retail cards can be a great way to get your children started, but they are seen less favorably than others when it comes to beefing up credit scores. Also, cosigning a credit card account with a child may help her learn how to be financially responsible, but does not count toward establishing credit in her name.
KNOW YOUR CHILD’S MONEY PERSONALITY
Joline Godfrey, author of Raising Financially Fit Children, believes that every young person is born with a money temperament. These personalities include the hoarder, spendthrift, scrimper, giver, beggar, hustler, and oblivious. As these names imply, children—just like their parents—differ when it comes to how they naturally handle money. Therefore, when coaching a young person to use credit responsibly, you need to factor in personality differences. For example, your son may be a hoarder, unwilling to part with his allowance, whereas your daughter is more of a spendthrift, with money burning a hole in her pocket. Most likely, your son will be ready to responsibly use credit sooner than your daughter. Your daughter may need more practice before she can reliably be left to her own devices.
PRACTICE MAKES PERFECT
The best way to help your children establish good credit is to allow them to practice healthy financial habits. Start by making them authorized users on your card and let them experience using a credit card to make purchases under your supervision. Next, help them apply for secured credit cards at the local bank. The credit limit is usually a few hundred dollars and secured by linked savings accounts in their names. Encourage them to make small purchases and pay off their balances in full each month. In time, their good behavior will be rewarded as the bank increases their limits and allows them to have unsecured debt. Eventually, it will be time for your young adult children to obtain additional credit cards. They don’t need to use these cards, but having two or three cards results in a more robust credit rating when it comes time for them to apply for a car loan or mortgage.
Rearing financially fit, creditworthy young adults is a slow process. In a world where you can immediately communicate with someone halfway around the globe and buy anything you desire by clicking a few buttons on your smartphone, waiting is not something many of us do well. However, if you are patient and teach your children the value of persistently working toward a financial goal, it will pay off. It may take a few years, but it will be a great feeling when you’re sitting in the living room of your daughter’s first home knowing only she is footing the bill.