If there's one area of finance your kids are unlikely to know about yet, it's credit. From understanding what it is, to how it works, learning about credit is key to helping your kids learn to make healthy financial decisions.
You may feel it's a while before your kids need to understand the world of credit, but as with all things financial, the sooner you start talking about it (in an age-appropriate way), the easier it will be. There are many reasons why it is important to teach kids about credit early for a start in today's economy, most people need to have good credit in order to rent a flat, buy a car, or even get a job. By teaching your kids about credit early, you can help them develop the skills they need to manage their credit responsibly and build a good credit history.
“It’s important to start teaching your kids about credit early on, because establishing good money habits takes time," says Louise Hill, co-founder and COO of GoHenry, “We know from our research that financial education helps pave the way for children, helping them to deal with their finances at every stage of their lives.”
Related: How old do you have to be to get a credit card?, Financial literacy for kids
Ways to teach kids about credit
-
Explain why credit is important
-
Explain the basics of credit
-
Explain that credit is not free money
-
Explain how to build credit
-
Explain what responsible credit use looks like
-
Show them what responsible credit use looks like
-
Discuss how they can monitor their accounts
-
Help them to start building credit for the first time
-
Get them a prepaid debit card
Explain why credit is important
Credit is a tool that can help you to achieve your financial goals. This is why it’s important for children and teens to understand it’s importance and use credit responsibly. Explain to kids that good credit can help you to:
-
Get a mortgage or car loan.
-
Rent a place to live.
-
Get a job.
-
Open a current or savings account.
-
Get a lower interest rate on loans.
-
Save money on insurance premiums.
-
Build your financial independence.
Explain the basics of credit
One of the most important facts to explain to kids about credit is that there is no good or bad to credit. This is because credit is a part of our financial lives. It helps us buy bigger things, for example, a mortgage for a house, a car, or a student loan to go to university.
Credit is a system that allows you to borrow money from a lender (person or company) and repay it over time, usually with interest. There are many different types of credit, including credit cards and loans.
Interest (also known as the cost of borrowing) on credit is a fee that lenders charge borrowers for the use of their money. The interest rate is a percentage of the borrowed amount charged each year. For example, if you borrow £100 at a 10% interest rate, you will be charged £10 each year. Interest can be a significant expense, so it is important to understand how it works and how to avoid it. Interest rates can be fixed or variable, depending on the provider.
To get credit, you will need to apply to a lender. The lender will then review your credit application and credit score (see below) and decide whether to approve you for credit. If you are approved, the lender will give you a credit limit, which is the maximum amount of money you can borrow.
This is why it's vital to know how credit works and how to build a good credit score. This is a numerical representation of a person's creditworthiness based on their credit history. This is calculated by three main credit reference agencies (CRAs): Experian, Equifax, and TransUnion, who then create a credit report based on the following:
-
Payment history: This is the most important factor in your credit score, accounting for around 35% of your score. It measures how well you have managed your credit in the past, looking at things like whether you have made your payments on time and in full.
-
Amount of debt: This factor accounts for around 30% of your credit score. It measures how much debt you have compared to your available credit, also known as your credit utilisation ratio. A high credit utilisation ratio can lower your credit score.
-
Length of credit history: This factor accounts for around 15% of your credit score. It measures how long you have had credit accounts open and how long you have been using credit responsibly.
-
Types of credit: This factor accounts for around 10% of your credit score. It measures the variety of credit accounts you have, such as credit cards, loans, and lines of credit.
-
Recent credit inquiries: This factor accounts for around 10% of your credit score. It measures how many new credit applications you have made recently. Too many new inquiries can lower your credit score.
Related: Explaining interest to kids
Explain that credit is not free money
One important element to talk about is how credit is not free money. Not only does it have to be paid back, but often you will pay back more than you borrow (this is known as interest).
Ask your kids to think of it this way: "Have you ever wanted to buy something for £15 but didn't have enough money? Maybe a video game, but you only have £5 so you need £10.”
When this happens, you have three choices:
-
Do without the item you want
-
Save until you have £15
-
Ask your mum or dad to lend you £10 and say you will pay them back (this is credit).
If your parents say yes, they may also say they will charge you an extra £1 for borrowing the money, this is known as interest.
This means the total you will pay back is £11 (£10 you borrowed + £1 in interest for borrowing it).
Explain how to build good credit
Building good credit is an important aspect of personal finance, as it can help you qualify for better interest rates on loans and credit cards, and save money in the long run.
-
Only borrow what you can afford to repay.
-
Make your payments on time, every time.
-
Keep your credit utilisation low (the amount of credit you are using compared to your credit limit)
-
Don't close old credit accounts.
-
Dispute any errors on your credit report.
-
Monitor your credit report regularly.
Related: How to build childs credit, How can a teenager build credit
Explain what responsible credit use looks like
The big problem with credit is that it can quickly get you into debt (debt is the amount of money owed to lenders). Explain to kids that their debt will keep rising if:
-
They borrow more money than they can pay back.
-
They spend more money than they earn.
-
A change in circumstances means you cannot pay back the money they owe.
-
They don’t pay on time (for this, they will be charged an extra fee from the lender).
Responsible credit is an important part of financial planning, so explain to kids that they should only borrow what they can afford to repay what they borrow. And that they need to make repayments on time as late payments can damage your credit score and make it more challenging to borrow money in the future.
Show them what responsible credit use looks like
Before your children are adults, it’s important to show them what responsible credit use looks like. One way to do this is to agree with them that when they borrow money from you, they have to pay it back by a specific date. Explain if this doesn’t happen, you will charge them a bit more as interest. This way, they can start to understand how borrowing, repayment and interest works.
At the same time, showing them the figures for how your mortgage or credit card works can be helpful. Show them a statement, explain what all the parts mean and point out the interest payments.
Discuss how they can monitor their accounts
There are several ways to check your credit score and see your credit report. Some credit reference agencies also offer free credit reports, which can be accessed once a year. Plus, several free credit report services are available in the UK, such as Credit Karma and ClearScore.
These services provide access to your credit report and score for free. Remember, your credit score may differ between credit reference agencies and lenders, as they each use their own scoring models and criteria.
Help them to start building credit for the first time
Although your teen can’t get a credit card until they are 18, you can add them to a credit card as an authorised user. With the right conversations and guidelines, adding your teen to your credit card account can help give them a deeper understanding of finances and debt. Also, by showing that they are linked to a credit account with a good payment history, it will help their credit score,
Bear in mind certain providers have a minimum age requirement of 13 to 16 years, so check with your provider. If they can’t become an authorised user, there are alternative ways for kids to learn about credit and get used to spending, such as a prepaid debit card like GoHenry.
Get them a prepaid debit card
GoHenry's mission is to make every kid smart with money thanks to a range of great features that help kids safely and securely learn about money, from saving to smart spending. In-app Money Missions makes learning about money fun and engaging with videos and quizzes covering everything from the value of money to budgeting. Parents can support their teens/kids through the GoHenry app by setting flexible parental controls and receiving real-time spending alerts whenever they use their GoHenry prepaid kids debit card.
Related articles
Activities to teach your child financial literacy
Teaching delayed gratification to kids
What's the difference between a debit and a credit card?
Can a teenager get a credit card?
