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How young is too young for credit cards?

Experts say it varies, but early teaching is key to gaining credit smarts

By Heather Stringer

Now that credit cards can pay for anything from the latest songs online to Little League sign-ups, kids need credit card smarts at younger ages. But few children know how to sidestep credit card traps or gain credit advantages by the time they're old enough for their own plastic.

Preparation for wise credit card use should begin early to help kids avoid trouble when they can legally apply for cards at 18.

How early? It varies, experts say. At age 7, most children are not ready to use their parents' cards as authorized users. At 12, mature-for-their-age kids might do fine with their parents' cards, but more impulsive preteens are better off using reloadable gift cards or debit cards. One thing is certain: They had better be ready by 18, when as adults they can stand -- or fall -- on their own.

Here are tips from experts for developing credit card skills in young people at different ages:

Preteen years
Financial education should begin as early as 4 or 5, says Mike Burton, president and owner of Burton Group Financial Advisors in Austin, Texas.

"Parents can use piggy banks to help them understand where money comes from and how it is earned. By age 4 or 5 they can start earning an allowance, and parents can give them a little budget that outlines what is for spending, what is for giving."

Parents also can pass on financial lessons by giving their children a safe place to make mistakes.

"Most people fail with any sort of new challenge," Burton says. "The question is when and how the failure will occur. It's better for kids to experience consequences in a loving environment rather than from a credit card company."

Bank of Mom and Dad
Burton suggests parents serve as a child's first creditor. For example, lend a sixth-grader money to buy something and give the child terms, such as a deadline for paying you back. Explain that there will be an increase in the payment if the child is late. If the debt is never paid, the agreement may include consequences such as taking away what the child bought, plus other possessions.

Although most credit card companies have no age minimum for becoming an authorized user on a parent's card, experts agree that a 7-year-old usually isn't mature enough to use a parent's card.

"What is different about becoming an authorized user on a credit card instead of using cash is that it is more abstract," says Craig Watts, a spokesman for the Fair Isaac Corporation. "This concept can be a mystery to many adults, let alone kids."

The card feels like "free money," but in fact it's like using cash you don't have to pay for things that could cost far more if interest rates kick in. Paying off the balance every month prevents that.

Bottom line tip for the preteen years: Preteens should learn that borrowing money costs money, and that when you borrow, you make a promise to repay.

Teen years
When children are ready, the next credit education step is to become an authorized user on their parents' credit card. The young authorized user can make purchases; parents remain responsible for paying the bill.

Money-savvy 12- or 13-year-olds could be ready to become an authorized user on a parent's credit card, says Linda Sherry, director of national priorities at Consumer Action, a nonprofit education and advocacy organization. Others may be better off with prepaid debit cards until they learn to control spending impulses.

Whenever parents decide to take the plunge by adding a child as an authorized user, they should be aware of the benefits and pitfalls.

The risk is that parents are solely responsible for the debt on the card, so a child's reckless purchases can damage parents' finances.This could happen if the child spends over the card's limit or buys more than parents can pay off that month. This could also harm a child's credit score, because the credit history of authorized users now feeds into that score.

'Piggybacking' ending
In the past,  parents with good credit who added a child as an authorized user passed on that good credit like an inheritance in a practice called "piggybacking." But because of what the credit industry viewed as an abuse of that practice, piggybacking will no longer be allowed when the new FICO formula, a new way of creating credit scores from Fair Isaac, FICO '08, rolls out. It will not take into account authorized users' credit history, but it won't be the only way to assess creditworthiness, says Rod Griffin, manager of public education at Experian, one of the three credit reporting agencies.

Experian will be the first of the three agencies to use FICO '08, a formula that creates a numeric score from the raw data of a person's credit history, but the key to qualifying for new accounts is having a credit history to begin with, Griffin says.

A legal dispute between FICO and the credit reporting agencies has slowed the new formula's rollout, but Experian expects to start using it in spring '08. The account users credit activities will remain part of the "raw data" that lenders may, if they wish, take into account, but won't calculated in the authorized user's score.

Despite the risks, and the newly limited reward, it still may be worthwhile to let a child become an authorized user. Children can try their credit card wings, while parents who track kids' purchases can discuss the consequences of the kids' spending choices.

Other options
Some parents will opt for other training tools. Elizabeth Gibbons, a California mother of three, did not want her children to make their first financial mistakes on her credit card. Gibbons and her eldest daughter, Paige, agreed that an ATM card would be safer. Paige would use the card to withdraw a limited amount of cash from her own account to spend at the mall.

"I am bad at putting money into savings and sometimes buy things compulsively," admits Paige, who was 16 when she started using an ATM card. "I would go to the mall if I was depressed and buy things like nail polishes and shirts that I'll never wear."

Bottom line tip for the teenage years: Credit has benefits and drawbacks. Rein in impulsive spending if you want to handle credit wisely.

Young adult years
Using credit cards as soon as they're legally able to apply for them at 18 can quickly affect teens' credit scores, which can influence interest rates on future loans or even the ability to edge out competitors when renting an apartment.

Issuers of student credit cards sometimes attract college students with offers for free pizzas or T-shirts. The students lured in might think they know more than they truly do about using credit cards responsibly, says Diane Cooley, assistant director for outreach in student fiscal services at the University of Washington in Seattle

Few seem to grasp the importance of paying off their balances each month, she says. For example, a student who has a card with a $3,000 limit, who charged it to the max in the first month and then made minimum payments thereafter, would need 11 years to pay off the debt, assuming an 18 percent interest and a minimum payment of 3 percent.

Students also do not usually understand the consequences of late payments, says Sherry. Late payments can trigger an issuer to impose sharply higher "penalty" interest rates of as high as 32 percent. The rate can stay elevated indefinitely, and it is the responsibility of the card holder to call the company and request that it be lowered after a series of on-time payments.

Parents, no 'bail-outs'
Parents should not rescue children who make financial mistakes, according to a study (purchase required) co-authored by Mary Beth Pinto, associate professor of marketing at Pennsylvania State University. When she explored credit card use among college students in four groups with varying degrees of parental involvement, she found that students whose parents helped pay their credit card bills had the highest average balances.  The lowest average balances were in the group of students who knew that paying the bill was entirely their responsibility.

The kids in the bailout group had the highest balances because "when they purchased things, they thought, 'It doesn't matter, I'll just call my parents and they will bail me out,' Pinto says. "There was no consequence for their behavior."

Pinto believes that kids need to understand that credit cards should not be used as loan installments, but simply as a convenience that should be paid off in full every month.

Bottom line tip for young adults: Use that first credit card wisely to establish credit. Applying the lessons learned earlier pays dividends when it's time for other 'firsts' such as a first car loan of first mortgage.

"Credit cards are powerful, and they can be used for good or bad," Burton says. "We can teach young people to be masters of that power or be exploited by it."

To comment on this story, write  Editors@CreditCards.com.

Published: January 22, 2008


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