Building Credit for Young Adults: How Credit Works and Where to Start

Every parent wants to give their kids a strong start. But while we spend years talking about safety, study habits and social media use, one critical life skill often slips through the cracks: establishing credit early and using it wisely.

The transition from “my parents handle this” to “I’m responsible for this” happens fast, and young adults with no credit history can find themselves shut out of opportunities they’re otherwise ready for. By gradually introducing the basics and offering guided experience, you can help them build the kind of financial footing that supports the big firsts ahead.

WHY BUILDING CREDIT MATTERS FOR YOUNG ADULTS

Obviously, your credit score matters when you’re applying for credit – which could be a credit card, a mortgage or a car loan.

But increasingly, credit scores are being used even when there’s no loan involved. For example, landlords often check the credit scores of prospective tenants, and home and auto insurers may check scores before putting an insurance quote together. Even prospective employers can run credit checks.

That’s because your history of paying back loans is seen as an overall indicator of responsibility and making good decisions – something landlords, employers and insurance companies care very much about.

If your credit isn’t good, they could refuse to take you as a client or employee or charge higher rates or a security deposit.

For young adults, the problem usually isn’t that their credit is bad – it’s that they have no credit history at all. And without a credit history and credit score, they could face problems getting their first apartment, getting hired, or getting insurance at a reasonable rate – or even being able to sign up for utility services.

As a parent, you can help your children start to build credit in high school or even earlier. Not only can it help alleviate some of the problems of not having a credit history, it can give them experience using credit smartly and responsibly.

WHAT IS A CREDIT SCORE?

HOW CREDIT SCORES ARE GENERALLY CALCULATED

While each credit bureau has their own methodology for calculating scores (and your score will vary somewhat depending on which you ask), there are several factors that they all consider.

• Payment history: Was each payment made on time in full, or were some late or missed?
• Balances: How much debt do you have?
• Length of credit history: How long ago was the first credit item reported?
• Credit mix: How much of your outstanding debt is secured (like a mortgage or car loan) or revolving (like a credit card)?

WHAT YOUNG ADULTS SHOULD UNDERSTAND BEFORE OPENING THEIR FIRST ACCOUNT

The usual way for someone’s credit history to start is when they first take out a loan or open a credit card. Before that, you’ll want to make sure they understand basic concepts, like these.

• As the person taking out a debt (including using a credit card), you are legally responsible for paying it back as agreed, and not doing so can have grave consequences, from destroying your credit to having property repossessed.
• If a negative item – for example, a late or missed payment – is reported to credit bureaus, it will generally stay on your credit report for seven years. That means something as seemingly inconsequential as an overlooked payment due date could eventually cause problems when you try to rent an apartment or buy a car.
• When a bank extends you credit, they generally believe you’ll likely pay it back – that’s the point of having a good credit score. They’re less worried about what you might have to go through to pay it back. For example, they may give you a credit limit of $10,000, and if you spend up to the limit and then have to move back in with your parents or sell your prized possessions to pay it, that’s on you as far as they’re concerned. So as the person using credit, you have to take responsibility for knowing what you can actually afford to spend and how you’ll pay it back.

TEACHING KIDS ABOUT CREDIT AND FINANCIAL RESPONSIBILITY

Depending on the age of your child, there are ways to introduce them to the idea of credit, credit scores and being financially responsible. They can be simple or sophisticated. Some schools even offer age-appropriate programs using play money to create an economic system in the classroom.

You can support financial literacy even in young children. As they get older, the topics and activities can get more advanced. Here are some ideas:

• Require them to save a portion of their allowances or cash gifts for big future purchases
• Allow them to take small “loans” and pay you back for something they want – to make it realistic and teach them the realities of debt, you can charge a low interest rate
• Explain your family’s budget to them at a high level, including how much you save for emergencies and goals, and how you make tradeoffs and spending decisions
• Introduce them to the ins and outs of credit card spending, from minimum payments to interest compounding to the impact on credit
• Show them your credit report and credit score and explain what’s behind it
• Help them run their credit report, ensure it’s accurate and strategize ways to start building credit and increase their scores

COMMON WAYS YOUNG ADULTS BEGIN BUILDING CREDIT

BECOMING AN AUTHORIZED USER ON A CREDIT CARD

If you as the parent are wondering how to build your kid’s credit score and you have good credit, this can be one of the easiest ways to help your child get on the same path. An authorized user is someone legally allowed to use your credit card. You simply let your bank know you want to add an authorized user and give them your child’s information. They’ll issue a card with your child’s name, but under your existing account.

Your credit card history, usage and payments will then start appearing in your child’s credit history. As you make on-time payments, their credit will reflect them. And they’ll receive the benefit of the length of time the account has been opened, making their credit history potentially years or decades long.

There’s often no age minimum to be an authorized user, so you can help to build credit for your child even when he or she is young. Crucially, you don’t have to actually give them the credit card and they never have to use it. But if you feel your child can use it responsibly, it could be a first step toward learning how the credit system works.

Always remember that the account is yours, and you’re responsible for any usage. If you do give your child the card to use as an authorized user and they rack up massive credit card bills, you’re on the hook for them.

FIRST CREDIT CARDS FOR YOUNG ADULTS

There’s no credit cards for kids, but at age 18, your child will be legally allowed to take out credit in their own name, so they can get a credit card (assuming they qualify).

Student or starter cards are a popular option. They have less stringent credit history requirements and low credit limits. Think of them like cards with training wheels.

If your child has used a debit card to access their savings up until this point, you both might wonder why you’d want to have them switch to a credit card. After all, “use only a debit card” is a common piece of advice when getting out of debt, and it could help you avoid ever being in that situation.

Unfortunately, using a debit card generally doesn’t help you build credit history, because there’s no responsibility involved – you can’t spend money that’s not in your account. (Credit cards can also have other benefits over debit cards, like increased fraud protection.)

Of course, if you don’t feel confident your child can responsibly use credit, you may not want to encourage them to take this step. Never rely on card issuers to help your child stay out of crippling debt – their business model is built to reinforce bad credit practices.

ALTERNATIVE CREDIT-BUILDING OPTIONS

Recognizing that some people might need other options for building or rebuilding credit, banks can offer additional ways to increase your credit score.

One example is a credit-builder loan. While it’s called a “loan,” in practice it functions more like a type of forced savings. You take out a small loan (typically a few hundred to a thousand dollars) and instead of giving you the money, the lender places it in an account for you. As you repay the loan, the funds become available and the payments are reported to the credit bureaus, helping increase your credit score.

Another example is a secured credit card, where you deposit cash as collateral and receive a card with a limit generally equal to the amount deposited. Again, as payments are made, they’re reported to credit bureaus.

Because credit-builder loans can charge high fees, they may not be the optimal way to build credit, but they could help if other options aren’t available to your child. One alternative way to build credit that could be free is through programs offered through the major credit bureaus that consider rent and utility payments (which aren’t typically reported).

HOW TO USE CREDIT RESPONSIBLY AS A YOUNG ADULT

Your kids’ ability to maintain a good credit score may depend on the information they get from you – while formal financial education is becoming more common, not all schools require it. Here are some of the things you may want to ensure they’ve absorbed.

MAKING ON-TIME PAYMENTS

Making payments on time has a massive impact on your credit score. Lenders and anyone else pulling your credit history can see every payment and whether it was late.

MANAGING CREDIT UTILIZATION

The percentage of credit used (vs. the amount available) also has a big impact on credit scores. For example, more than 30% of credit used has a highly negative impact – that translates to a $300 balance on a card with a $1,000 limit.

MONITORING CREDIT REPORTS

Building credit is just the first step – it's important to check credit periodically, especially if you’re planning to apply for a loan soon. Keep an eye out for incorrect information and fraudulent activity – and take action to strengthen your credit if your score is low.

COMMON CREDIT MISTAKES YOUNG ADULTS CAN ENCOUNTER

OVERSPENDING AND HIGH UTILIZATION

The biggest fear many people have about credit cards is the ability they give someone to overextend themselves financially. It’s so easy to just whip out a card every time you want something. But blowing your budget can devastate your financial security, and overusing your card (even if you stay under the limit) is detrimental to your credit score.

MISSING PAYMENTS OR IGNORING STATEMENTS

As bad as high credit usage is for your score, it’s not as bad as missing payments. Even one late or missed payment will hurt your score, and repeated ones will tank it.

OPENING TOO MANY ACCOUNTS TOO QUICKLY

Applying for a lot of cards in an attempt to raise your overall limits – thereby pushing down your percentage of credit used – can backfire. Credit bureaus view a lot of new credit lines opened in a short time as a bad sign for your likelihood of responsible use.

HOW A FINANCIAL ADVISOR CAN SUPPORT FAMILIES WITH CREDIT EDUCATION

A financial advisor can help you find smart ways to support your kids in starting their financial lives on the right foot, whether they’re thinking about credit, education financing or even buying a home. Getting the right start – even with a helping hand from their parents – can help set up young adults for a healthy financial future.