Many parents teach their children the ABCs at a very young age, but do they teach them the ABCs of good credit early enough in life? In some cases, probably not.
At certain points in life, everyone will have to deal with banks, loans, credit and finances. You may have learned your lessons through the “school of hard knocks,” and with your insight and experience, you may be able to help your children steer clear of some of the headaches you have encountered.
The three C’s of good credit
It is essential to teach your children the importance of capacity, collateral and character. When issuing a loan, a bank may consider how the applicant measures 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 a pledge 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 come at a higher interest rate.
Character is what a creditor will use to determine the reliability of a loan applicant. The creditor may consider such points as how long an applicant has owned a car or home, or whether the applicant pays his or her rent and other loans or bills on time.
Establishing a good credit record
It is often difficult for a young person to establish good credit, because they have no previous track record of paying bills or making loan payments. Lacking a credit history makes securing a first loan difficult, and yet, without that first loan your child can’t establish a good credit record. As a parent, you can help your child take the first step toward attaining credit by helping them open a checking and/or savings account. A creditor will look at such accounts as an ability to manage money.
Another step on the road to good credit would be for you to co-sign a loan application for your young adult child. As a co-signer, you are agreeing to pay back the loan in the event that your child fails to do so. Therefore, communication and trust between you and your child is paramount to ensure payment will be made by your child.
Maintaining a good credit record
There is only one way to keep a good credit record: Pay everything off on time! Make sure your children are aware of how much they owe at all times. In addition, try to have your children avoid owing more than can be paid back. Advise your children not to dig holes so deep they won’t be able to climb back out.
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.