Part 4 of this series introduced the money management skill revolving around credit. However, one cannot get credit without demonstrating credit worthiness and achieving a solid credit rating (i.e., credit score). So, let’s dive into what a teen needs to know about credit scores!
Here is what I know for sure …
Even if someone strives to use cash for everything, at some point there may be a need to apply for a line of credit for something big (e.g., house, car, land, school loan, etc.). Having a good or excellent credit score will facilitate this process and teens need to start to build their own credit score now.
Concepts to cover regarding credit scores …
- What is a credit score?
Make sure the teen(s) you are working with knows that a credit score is about credit worthiness and the probability that a person will and can repay an obligation. Lenders will use the score to determine if a person qualifies to receive credit, what interest rate they will have to pay, and what credit limits will be put in place (all important factors that are often overlooked by even adults).
A credit report draws a picture of one’s current credit usage, debt, and payment history. It is portrayed through a number called a credit score. When a person wants to borrow money, lenders will want to know a person’s credit score to assess the likelihood that the money lent will be repaid.
Almost anyone can qualify to get credit, but your credit score will determine how dearly you will have to pay (in interest) as you repay a loan. So, working on a “good” or “excellent” credit score from the get-go is a solid strategy.
Stress that the higher the score, the better.
- What is a “good” credit score?
The highest credit score a person can earn is 850, so a score of 700 or above is considered a good rating. Here is a scale to use as a reference:
|Excellent||750 – 850|
|Good||700 – 749|
|Fair||650 – 699|
|Poor||600 – 649|
|Bad||300 – 599|
- What factors impact a credit score?
Payment history, amount owed, length of credit history, amount of new or recent credit, and types of credit used will all impact a credit score.
Paying on time is the number one factor that impacts a credit score rating in a positive way. Actions like taking forever to pay off a debt, owing a large overall amount of money to others, and using a variety of credit will be looked at by the credit score bureaus and have a negative impact when determining a credit score.
Often teens have the misconception that it is through the paying of monthly interest charges that builds their credit. Not sure where they got this crazy idea, but please make sure you discuss that paying in full, on time, every month will build their score the most!
- Who creates and calculates a credit score on someone?
A person’s credit score is generated by companies like Equifax, Experian, TransUnion (these are the 3 largest reporting agencies or bureaus). They collect data on individuals’ financial history and assign a corresponding number score. Lenders can then “run a credit report” to see if a person is a good risk before extending credit. Teens often have never been taught this fact.
Please make sure your adolescent knows that everyone is entitled to one free copy of their credit report every year, from each of the three nationwide credit reporting companies. (Often there is a charge for additional reports requested by an individual). However, if a lender runs a credit report on a person, the lender will have to pay any fees involved…also good for teenagers to know.
- How can a teen start to build a credit score and learn fiscal responsibility?
This question has numerous answers, but I will propose these ideas for you to contemplate with your teen(s):
- Open a checking and savings account to establish a relationship with a financial institution.
- Get a Secured Credit Card (pre-paid card) or Student Credit Card—use it and pay fully on time.
- Get a job to demonstrate responsibility and earn money.
- Have a household bill put in your teen’s name and have them pay monthly (even if you supplement the payment)
- Go to a local bank and take out a small loan (e.g., $1000). Make monthly installments on this loan.
- Continue to learn about credit and money matters by reading and talking to others.
And that is about it for the basics on credit scores. More details can be found in L.I.F.E. – Independence Readiness.
The final blog in this series will be coming to you in early April, so don’t miss it!