Responsibility is a key lesson for teenagers, and a big part of financial responsibility is managing credit. Although legally a person cannot apply for a credit card in their own name until they’re at least 18, teaching your teenager these tips can help give you confidence that they’ll make the right decisions once they’re able to apply.
1. Understand what ‘credit’ means
This will probably seem obvious for those who’ve been using a credit card for years, but clearly defining credit as something that has to be repaid, usually within a certain timeframe, is important. If your adult teen doesn’t repay debts on their credit card on time, this can lead to penalties and also impact their credit rating.
2. Avoid interest repayments
Interest is what a borrower pays a bank or other lenders for using their money. The rate varies depending on the financial institution and the type of account. Even if your adult teen has an interest-free credit card they need to ensure certain conditions are met – anything bought outside these terms will accrue interest.
In a nutshell:
- Pay off the balance in full and on time – interest won’t be charged.
- Pay the minimum repayment each month – interest will be charged on anything left owing.
- Miss the repayment date or minimum repayment amount – typically a late fee will be charged, plus interest on everything owing.
3. Use credit only for purchases
Withdrawing cash from a credit card will incur a fee. Cash advances or ATM withdrawals on a credit card also incur higher interest rates than card purchases. Explain to your teen that ideally they should use a debit card for cash transactions, and reserve their credit card just for purchases.
4. Keep the future in mind
When the time comes for your child to take out a personal loan or a home loan, a healthy credit history can make a big difference. Make sure they understand that decisions made now could impact their future. Using credit wisely and making repayments on time is a good demonstration of financial responsibility to prospective lenders.
5. Borrowing the right amount
Your child probably knows not to borrow more money than they can afford to pay back, but it may be easier for them to decide how much to borrow and how much they can repay if shown how to set a budget. Doing this gets them into the habit of putting money aside to pay for things.
There is no better practice than a real life example. If they want to borrow money from you to buy something like a new mobile phone, sit down with them and go through their income and outgoings, and work out what they’ll need to set aside each week to pay you back.
You can also get them thinking about future financial circumstances and how any changes, such as changing casual jobs, could affect their repayments. Getting in the habit of doing this any time they borrow money will help them avoid borrowing too much when they’re older.
6. Getting interested in interest
The key thing to teach them about interest is that borrowing money from the bank is essentially a service that you pay for – it comes at a cost. Also, the longer someone takes to repay their credit, the more interest they’re likely to pay back overall.
7. Credit history matters
What your teen should understand about credit history is that being financially responsible now, will impact any future applications for personal credit. They can start to build a healthy credit history by using their bank account on a regular basis and by not allowing it to become overdrawn.
When your child opens their bank account they can get a debit card to pay for things themselves online or in store. This can also help demonstrate they have strong money management skills, which will help build a positive credit history for the future. Once they do take out credit, to maintain the good history they have built up, they’ll need to make sure they meet their repayments and don’t overspend.
8. Not all credit is the same
There’s a big difference between borrowing money using a credit card and through a personal loan, so your child will need to consider their circumstances.
With a credit card they’ll be given a credit limit. They will be charged interest on whatever credit they spend on their card and don’t repay within the billing period. Credit cards tend to be used for things they want to buy now and pay back at a later date.
A personal loan on the other hand is where they will borrow a fixed amount over a set period of time for a certain interest rate. This might be more suitable for larger ticket items such as a car.
While it’s valuable teaching your child about credit so they can make responsible choices for the future, a long-term savings plan is also another good option for financing those bigger ticket items.