Many parents teach their children the ABCs at a very young age, but do they teach them the ABCs of good credit?
At certain points in life, everyone must deal with banks, loans, credit, and finances. You may have learned your lessons through the “school of hard knocks”— if so, you can use the insight you gained from your experiences to help your children steer clear of some of the difficulties you encountered.
The Three “C’s” of Good Credit
Good credit can help your children secure the funding they need to purchase a new home or car, or start their own business. In order to establish good credit, it is essential that your children understand the roles of capacity, collateral, and character. When issuing a loan, a bank may consider how the applicant rates in each category.
Capacity poses the question, “What financial resources do you have to pay back the loan?” As the creditor, the bank most likely will ask, “How long have you held your job? How much do you earn? How many dependents do you have, and do you pay child support?”
Collateral concerns what the applicant will use to secure the loan. For example, a creditor may want to know if your child owns a car or has any personal savings that can be used as security against the loan. When your child pledges an asset as collateral, he or she is promising to use the asset for repayment if, for any reason, he or she is unable to pay the balance of the loan. Personal loans generally do not require collateral, but they may have higher interest rates than other loans.
Character is what a creditor assesses to determine the reliability of a loan applicant. The creditor may consider such information as how long an applicant has owned a car or home, or whether the applicant pays the rent and other loans or bills on time.
Establishing a Good Credit Record
It is often difficult for young people to establish credit because they have no previous record of paying bills or making loan payments. While a lack of a credit history makes securing that first loan difficult, without that first loan, your child cannot establish a good credit record. As a parent, you can help your child take the first step toward attaining credit by helping him or her open a checking and/or savings account. A creditor may look at such accounts as an indicator of your child’s ability to manage money.
Another step on the road to good credit is for you to cosign a loan application for your young adult child. As a cosigner, you are agreeing to pay back the loan if your child fails to do so. Therefore, communication and trust between you and your child is essential, to ensure that your child will make payments in a timely and responsible manner.
Maintaining a Good Credit Record
There is only one way to keep a good credit record: pay everything off on time! Make sure your child is aware of how much he or she owes at all times. In addition, try to have your child avoid owing more than can be paid back. Help your child understand that if he or she digs a deep financial hole, it may be impossible to climb out of it.
If you take the time to teach your children these basic concepts, they will have a solid foundation to help them avoid the pitfalls that many young people face when they begin to build their credit foundation.