By: W. Kirk Taylor, CFP® & Gaby S. Dominguez
This article is Part One in a two-part series for Confident Kids℠!
Credit. It’s a word that carries immense weight in the realm of personal finance, yet it remains shrouded in mystery for many teens and young adults. As NextGen’s study reveals, the majority of high school students are navigating the world without any formal education on personal finance, leaving them ill-equipped to understand the intricacies of credit and its impact on their financial future.
Parents, too, often find themselves stumbling when it comes to discussing money matters with their children. The discomfort stems from various sources, including a lack of confidence in their own financial situation and a fear of passing on their mistakes. However, avoiding these crucial conversations only perpetuates the cycle of financial illiteracy.
Demystifying Credit
At its core, credit is the ability to borrow money with the promise of repayment in the future. Whether it’s a student loan, credit card, or mortgage, credit allows individuals to access goods and services when they need them, deferring payment until later. But this convenience comes at a cost — namely, interest charges and fees.
Your journey into the world of credit begins with establishing a credit history. Every time you borrow and repay money, you\’re building a track record that lenders use to assess your creditworthiness. This information is compiled into a credit report by agencies like Experian, TransUnion, and Equifax, which then generate a credit score ranging from 300 to 850.
Understanding this three-digit number is crucial. It not only determines your ability to borrow but also influences the interest rates you\’ll receive. With a high credit score, you gain access to better financial opportunities, from favorable loan terms to higher credit limits.
But how can you ensure a winning credit score? Think of it as a game with five key strategies
- Payment History (35%): Pay your bills on time to score big in this category.
- Amounts Owed (30%): Keep your credit utilization low by borrowing responsibly.
- Length of Credit History (15%): Maintain long-standing accounts to show your reliability.
- New Credit (10%): Avoid applying for multiple lines of credit in a short period.
- Credit Mix (10%): Diversify your debt portfolio to demonstrate financial responsibility.
For teens and young adults, building credit can feel daunting. However, there are ways to ease into the process. Authorized user cards and secured credit cards offer entry-level options, allowing individuals to piggyback on a parent\’s credit history or provide a cash deposit as collateral, respectively.
Moreover, understanding the importance of credit is paramount. Good credit opens doors to major purchases, secures access to credit cards, and even influences employment and housing opportunities. But with great power comes great responsibility.
If you find yourself in debt, don’t despair. Take proactive steps to regain control of your finances
- Stop borrowing money immediately.
- Craft a realistic budget to manage your expenses.
- Build an emergency fund to cushion against unforeseen setbacks.
- Prioritize debt repayment, focusing on high-interest accounts first.
- Explore opportunities to increase your income and accelerate debt payoff.
- Don’t hesitate to negotiate with creditors for better payment terms.
(Stay on the lookout for Part Two of this series, where we will dive into debt more deeply!)
In essence, credit is a double-edged sword — a powerful tool when wielded wisely, but a potential pitfall when mismanaged. By arming yourself with knowledge and adopting responsible financial habits, you can navigate the complexities of credit with confidence and secure a brighter financial future. After all, mastering the game of credit is not just about winning; it’s about ensuring long-term financial success.
Sources
(1) Personal Finance for Young Adults: Understanding Credit, Halsey Schreier, June 30, 2020, https://www.forbes.com/sites/halseyschreier/2020/06/30/personal-finance-for-young-adults-understanding-credit/?sh=77290fd33d5a
(2) How to Teach Your Teens About Credit, Dia Adams, November 27, 2020, https://www.forbes.com/advisor/credit-score/teaching-teens-about-credit/
(3) Ultimate Guide to Understanding Credit for Kids, Teens, and Young Adults, Credit Critics, https://creditcritics.com/credit-guide/