How To Teach Your Kid About Credit

John Vaughan (Financial Advisor) @ Lucid Living

When it comes to credit literacy, we could all use a little help.
Approximately two out of three adults haven’t gotten a copy of their credit report in the past year—even though it’s free—and almost one in three doesn’t know her credit report score, according to the 2011 Consumer Financial Literacy Survey.

Of course, we’d rather our kids not join these ranks when they grow up. As too many South Africans know firsthand, it’s harder for adults to crawl out from credit card debt than it is for babies to, well, crawl.

We want to teach our kids responsible habits from the get-go, so they never find themselves in the hole.

Here’s how to teach your kids about credit early on:

1. Obviously we’re not going to suggest teaching complicated credit concepts to a toddler, but, in the meantime, you can teach your kid some basics about patience. After all, in order to purchase a home with the best home loan terms, we adults need two things: a good credit report and a substantial down payment, both of which require time and patience to build.

To communicate the concept of patience, try the Marshmallow Test. Give your kid a marshmallow. Tell her she can have a second one if she waits 20 minutes before eating the first one. Depending on what she did, ask her questions like, “Are you glad you waited for the second marshmallow?” or “Why didn’t you wait long enough to get the second marshmallow?”

To really drill in the idea of patience, use this same strategy with other moments in life, as well. For instance, if she wants dessert, make her finish her vegetables first. Or if she asks for a particular toy, tell her she can have it, but she’ll have to wait for her birthday. Teaching her to delay gratification now will make it easier for her later in life, when concepts like paying for a house come into play.

Keep in mind that even though the kids who passed the original Marshmallow Test over 40 years ago did better in many areas later in life (with things like behavior, obesity and even drug use), there’s no need to worry if your child is the more impulsive type. Focus on teaching your kid to ask herself questions before taking action, such as, “Why should I wait for the toy I want?” and “Will I be sad if I don’t wait?” As she gets older, she may recall what you taught her and ask herself the same questions when impulse strikes.

2. Introduce the idea of borrowing money when your kid is in grade school. When she wants to buy something that you don’t want to pay for in full, give her two options: wait until she has enough cash saved up, or receive a loan from you. Tell her she can have the loan only if she agrees to pay it back by a certain date, which you can mark on the family calendar. And help her set up means to earn that money, whether it’s by saving up her allowance, doing extra paid chores around the house or taking on odd jobs for neighbors.

Then introduce the consequences: If she doesn’t pay you back by the due date, she’ll have to pay a little extra. This will teach her the basic concept of paying interest as well. She may stumble a few times, but it’s much better that she default on a debt repayment to you rather than experience the consequences of defaulting on her credit card later in life.

3. A good time to teach the concept of credit report scores is before your teen heads off to university. While you may not be comfortable sharing your credit report score with him, try to explain the concept in an understandable way. Show him Lucid Living’s plain language Credit Report, a report that most students will understand.

Explain that banks and lenders are kind of like university admissions counselors deciding whether to admit a student: They’ll take a look at his credit “grade” to decide his creditworthiness. Just as his performance in school can affect his chances of getting into his dream university, his credit habits will have a big impact on whether he’ll get the best terms on a loan or credit card.

4. When the time is right, open up a new credit card account with a relatively low limit and add your teen as an authorized user. It’s usually a good idea to get her started using a credit card either late in high school or right before she goes off to university so you can help—and keep tabs on—her while she’s still at home. Since credit history accounts for 15% of one’s credit report score, helping your teen get a good jump on this can make a big difference for her future.

Your child is nearly an adult, so she’ll appreciate being treated as one. Draw up a contract with her to decide what the card will be used for and who will pay the bill. Make sure to add in the consequences of breaching contract (she will pay you interest, you will make her pay the whole bill, etc.). At all times, if the arrangement is not going as planned, you can remove her as an authorized user from the account. Once she’s in university, follow this helpful advice … just try to keep her on track without sounding patronizing.

5. The best lessons come from simply talking with your child about why you make the credit choices you make and explaining the concept of borrowing money. Above all else, teach by example, and take everyday experiences as a constant opportunity to teach a lesson about smart credit and financial habits.