5 ways to help your college kid build credit
By Tina Orem
November 13, 2014
For many people, the college years are a fantastic time to let go and find yourself. Experiment.
They're also a perfect time to make spectacularly bad decisions, some of which your friends will razz you about for decades.
That's why to financial advisers, college can be one of the riskiest times in a person's life. Being in your early 20s often means having a blank credit slate that can be ruined easily, leaving years of unmanageable debt payments, loan rejections and even shattered job prospects in its wake.
“The worst thing a college-age kid can do is sign up for a credit card, max it out to pay for spring break and then throw away the monthly notices. This is exactly what I did and I had a [great] time, but paid the consequences for it later. And it's also one of the main reasons I got into financial planning and advising — to help my clients and my children not make the same mistakes I did,” says Bill Davis, executive vice president at Apex Financial Advisors
We reached out to financial advisers to find out what you can do to help your college-age son or daughter build a credit score worthy of the dean's list. Here's what they said:
1. Co-sign on a credit card with your son or daughter.
“Due to the Credit CARD Act, adults under the age of 21 cannot obtain credit on their own unless they can prove ability to pay or have a co-signer,” says Gail Cunningham, spokeswoman for the National Foundation for Credit Counseling. “Therefore, one of the ways parents can help their student build credit is to co-sign on a credit card for them.”
But Cunningham has words of caution. “When you co-sign, you're equally responsible for full payment of the debt. Don't ever co-sign unless you are prepared to take on that responsibility. Further, all activity is reported in both signers' names, so if the child is responsible for the payments, the parent should make sure they are being made in full and on time each month, or the negative activity will be reflected on their credit report,” she says.
2. Put up the collateral for a secured credit card.
If taking on credit isn't an option (perhaps the parents have credit issues or don't believe their child is quite ready for a credit card), then a secured card from a reputable bank can be a great option, says Anthony Kirlew, who runs the FiscallySound.com blog and is co-author of “The Bankruptcy Mortgage Book.”
Here's how it works: You put up the security deposit, of, say, $300, then your child gets a card with a charging limit of $300. She can build her credit with the card, eventually qualifying for a traditional card with a larger limit. Prior to signing up for the card, make sure the issuing bank reports the card's payment activity to the credit bureaus.
This strategy has a catch. “It is important that the student understands how this works and they have an agreement with the parent regarding what they can charge on this card, such as school books, doctor visits, medication, etc.,” business coach Nancy Butler cautions. Be sure to read all the card's terms and conditions together to understand how any fees will be applied as secured cards tend to be fee-heavy.
3. Co-sign on a car loan.
“This shows lenders the teen is able to make a major purchase (it will show as an auto loan on the credit file) and make the repayments responsibly,” says Evan Hutchinson of the Hutchinson Group
What's the downside of this strategy? “If the child doesn't make the payments, the parent is usually on the hook for the missed payment and both credit reports could be damaged for late payments,” Hutchinson says. The only way to remove a parent as a co-signer is to have the adult child refinance the loan in his or her own name — until then the parent essentially co-owns the car.
4. Make your son or daughter an authorized user on your card.
An authorized user gets full charging privileges, but is not responsible for payment, . Meanwhile, the on-time payments go onto both cardholders' credit reports, building your child's credit history.
Setting spending limits and having online access to the account are key to ensuring that spending does not get out of hand, Cunningham says.
Authorized users get their own cards with their name on it. If charging privileges are abused, all the parent has to do is call the issuer and have the authorized user removed from the account.
5. Step away from the helicopter.
Financial planner and author Tana Gildea says financial mistakes can be blessings in disguise, because they provide teachable moments. “Teach them to immediately take responsibility for the issue and take corrective action,” she says. “Years down the road, these little bumps can pop up (usually when buying a house) and they need to be prepared to explain the issue with a focus on how it got resolved.”