Setting Up Your Teen for Financial Success | How to Build Credit as a Teenager

Establishing a credit history is crucial to any teen's financial future. Once you reach adulthood, credit plays a key role, influencing your ability to secure loans, credit cards, and even housing. Learning about credit and actively participating in credit-building activities can set teens on the right financial path before they even graduate high school.

As a parent, we hope you find this guide useful as a conversation starter. Share it with your teen, explore the key points, and decide how you can work together to set them up for financial success.

Explaining the basics of building credit

Building credit is like building a good reputation with money. It's essential for when you're older and need to borrow money for things like buying a car or a house. Without any credit history, teens can rely on their parents' credit as a stepping stone to building their own.

When dealing with money and finances, it's important to be responsible, avoid making late payments, and only borrow what you can afford to repay. By building good credit, you'll have more opportunities as an adult to get loans and make purchases when you need them.

What is credit and how does it work?

Credit is like borrowing money from a friend but with a more formal agreement. For example, let's say you want a car. Vehicles are expensive, so it takes a long time to save enough money to buy one. Most people can only afford to finance a car – or buy it on credit – which means taking out a car loan. Financing a vehicle allows you to drive it home and use it while you pay off the loan.

Unlike borrowing money from a friend, however, you have to pay a bit more than you borrowed when using credit. That extra money you must pay is called interest. Think of it as the fee you pay for using credit. How much interest you'll pay varies by lender and the type of credit you use, but it's usually a percentage of the amount you've borrowed or financed.

Why building credit is important for teens

Good credit can help you qualify for better interest rates on future loans, which saves money whenever you need to finance a big purchase. Having a strong credit and payment history can also help you land an apartment or job. Lenders, property managers, and employers want to know they can trust you. That's why they often look at your credit to see whether you're financially responsible and can pay your bills on time.

But building credit takes time and consistent effort, so it's easy to lose sight of your goal. Having a parent work with you on establishing a credit history can streamline the process.

There are many reasons to start establishing credit as a teenager. For starters, having good credit at a young age can help you:

Gain financial independence

No matter how much money you earn, whether it is from a part-time job or an allowance, learning how to manage your finances helps you establish financial independence. You'll learn the importance of responsible spending and how to make monthly payments on time. These are skills you'll need when you head off to college or move out on your own.

Access financial products

Excellent credit and a strong payment history can help you access more credit-based products, such as credit cards, loans, and even rental agreements. Having a good credit mix can help you afford major purchases like a car or a house sooner rather than later.

Get lower interest rates

We've already mentioned how having good credit can lead to lower interest rates. As you start to access more loans and credit cards, reduced interest can save you a significant amount of money over time.

Find more employment opportunities

Some employers perform credit checks as part of their hiring process. That's because your credit history demonstrates how responsible and reliable you are as a prospective employee. If you have bad credit, the hiring manager may decide against offering you a job.

Develop good financial habits

Building credit early instills good financial habits that can last a lifetime. Learning the importance of budgeting, making on-time payments, and maintaining a positive credit history can be a tremendous help as you start to navigate the world of personal finance on your own.

8 steps to building credit for teens

Now that you know how credit works and why establishing a good credit history is so important, it's time to get your parents involved. Together, you can work on hitting these financial milestones during your teenage years:

1. Open a savings and checking account

Opening a joint bank account with a parent will teach you how to manage money and pay bills electronically while still having your parent as a financial safety net. And, even though most modern transactions involve debit cards, you'll still need to know how to write paper checks. Learning these banking basics will come in handy as you enter adulthood.

For parents: Many banks and credit unions offer teen checking accounts that allow you to be a joint account holder. Most have a minimum age requirement of 13 — but check with your bank for specifics. Depending on the account features offered, parents should be able to monitor their teens' saving and spending habits, authorize money transfers, and limit digital access via parental controls.

2. Check and review your annual credit report

Learning how to check your credit report is important to understanding your financial history. Here's how you do it:

• Visit AnnualCreditReport.com, the only federally authorized website for free credit reports.
• Follow the instructions on the website to request your credit report. You might need to provide your name, address, Social Security number, and other details to verify your identity.
• Once you get your credit report, take the time to read and understand it. Check if your personal details, such as your name and address, are correct. Look for any mistakes or information that seems off.
• If you find any errors, like an account you didn't open, take action. Make a note of the mistake and get a parent to help you gather any supporting documents that prove it's wrong. You can then contact the credit bureau to dispute the error.

For parents: Make sure your teen understands the importance of addressing credit report errors. Show them how to find documentation that supports their case and help them submit disputes to the credit bureaus. Instilling this proactive approach to credit monitoring early on will help your teens take charge of their financial well-being.

3. Keep an eye on your credit score

Your credit score is a three-digit number that shows how well you handle money. The higher the score, the better your financial reputation. Unfortunately, your credit score isn't included in your annual credit report, which can make checking it tricky.

If you have a credit card or auto loan, you might find your score listed on your monthly statement or on the app. You can also get your score from one of the three main credit bureaus, but you may have to pay a one-time fee or monthly subscription.

For parents: Credit score monitoring is typically included in identity protection services. You might consider enrolling in a basic membership to safeguard your child's identity if you prefer an extra layer of protection.

4. Become an authorized credit card user

Legally, you aren't allowed to get your own credit card until you turn 18. But your parent or guardian can add you as an authorized user on one of their own credit cards.

Being an authorized user means that you can use your parent's credit card, but you're not legally responsible for the debt. Your parent requests to add your name to their credit account, and the credit card issuer sends you a card with your name on it.

As an authorized user, you can use the card to make purchases just like the primary cardholder (your parent) does. This is a great way for your parent to give you the convenience of using a credit card while keeping control over the account.

For parents: Authorized users can enjoy the same perks as the primary cardholder, such as fraud protection. Your teen will also benefit from your good payment history, building credit through your own credit reports.

5. Start using a secured credit card

Once you turn 18, you can apply for a secured card with little to no credit history. Secured credit cards require a security deposit up front. The amount you deposit determines your spending limit. For example, if you deposit $200, your credit limit would typically be around $200.

By using a secured credit card responsibly, you can demonstrate your ability to manage credit and make on-time payments.

For parents: It's important to remind your teen that the security deposit is not used to make payments. Rather, it acts as a safety net for the credit card company in case they fail to pay. They can only build credit by using the credit card consistently and paying on time.

6. Get a co-signer for a loan or credit card

You'll have to be 18 for this one, as well — but having a parent co-sign a loan or credit card can help you access credit you maybe otherwise couldn't get.

A co-signer is someone who agrees to take equal responsibility for your loan or credit card. The person who co-signs can improve your chances of approval because lenders consider the co-signer's credit history and income.

It's important to note that your adult co-signer is taking on a lot of responsibility by letting you use their name and financial reputation. If you fail to repay the debt, they're responsible for the amount you owe.

For parents: If you agree to be a co-signer for your teen, be sure to set clear boundaries, establish expectations for credit card usage, and educate them about responsible credit habits.

7. Get a student credit card

Qualifying for an unsecured credit card on your own can be tricky when you haven't established a strong credit history. Fortunately, student credit cards are designed for teens 18 and older who need to build credit, learn good credit habits, and access cardholder rewards and benefits (like credit-score monitoring).

Student credit cards offer several advantages. First, they often have lower credit limits, which helps you learn how to manage your spending without getting into excessive debt. These cards also come with special perks and rewards tailored to students, such as cashback on textbooks or restaurant discounts.

Before filling out a credit card application, look for a student card with no annual fee and a low interest rate. You also want a card that reports to the major credit bureaus, as this will ensure your credit activity is being reported and impacting your credit history.

For parents: Help your teenager understand the importance of using their student credit card responsibly. Encourage them to make small purchases and pay off the balance in full each month. This will demonstrate their ability to manage credit effectively and help to establish a positive credit history.

8. Apply for a credit builder loan

Credit builder loans are different from most personal loans because they're designed to help you establish a credit history. The loan amounts are usually smaller (think $500 or less), and the loan amount stays in the account until you've paid the loan in full. Once you've paid off the loan, you receive the funds (minus interest).

Credit builder loans are a smart way to build credit because your payment history is reported to the credit bureaus. They also tend to have lower interest rates than regular secured credit cards.

For parents: If your teen is interested in a credit builder loan, help them compare options and choose one with the lowest interest rate. Remind them that if a lender offers them a higher interest rate than what you expect, they should look elsewhere.

Essential credit habits for the savvy teen

Everyone's credit journey is different. Whether you become an authorized user while in high school or your first loan is a college student loan, it's imperative to maintain healthy credit habits. This is so you continue to build good credit and don't get overwhelmed by debt.

Being responsible for your credit and finances comes down to:

Making your monthly payments on time

Late and missed payments negatively impact your credit history, leading to a poor credit score. You must make minimum payments every billing cycle to maintain good credit. When possible, pay more than the minimum amount or pay off the entire balance every month. Doing the latter will improve your credit score more quickly.

Keeping your credit utilization ratio low

Credit utilization refers to how much of your available credit you've used. Let's say your credit card limit is $1,000. If you've spent $500, your credit utilization is 50%.

The credit bureaus view you as more responsible when your credit utilization ratio is low. Most experts suggest aiming for a credit utilization ratio below 30%. This means you shouldn't spend more than $300 of a $1,000 credit limit. You certainly can spend up to your maximum credit limit, but it might negatively impact your credit score.

Saying "no" to unaffordable splurges

Credit cards make it easy to splurge on expensive purchases, but that's how people end up in financial trouble. If you can't afford to buy something with your debit card, you shouldn't buy it on credit.

There are exceptions, of course, like financing a house or a car. But in general, you should avoid excessive debt and aim to pay off your credit card balances each month.

Achieving financial independence together

For anyone, building credit requires discipline and financial know-how. But developing good financial behaviors early can help set you up for an adult life free of financial hardships.

Teens: Remember that you control your financial future. Spending within your means and avoiding excessive debt are worthy goals that rank right up there with landing a job and a good source of income. With these tips in mind, you can save more money, learn to use credit responsibly, and build a strong financial foundation for adulthood.

Parents: Try to utilize your own credit profile to boost your teen's credit rating before they turn 18. At that point, they can apply for their own lines of credit. Advising them on how to budget, save money, and make wise financial decisions now will give them a competitive advantage later in life.

Discover more Money Tips that can benefit the whole family on the Advance America blog!