Have you ever wondered if everything you’ve heard about teen credit is true? As a parent, navigating the world of credit with your teenager can feel like walking through a minefield of misinformation. Let’s debunk some shocking teen credit myths and uncover what every parent must know about credit!
Teen credit myths can significantly impact how young adults approach their financial future. From misconceptions about credit cards to misunderstandings about credit scores, these myths can lead to poor financial decisions that may affect your teen’s credit for years. Parents must separate fact from fiction to guide their children toward responsible credit use and a solid financial foundation.
Let’s dive into five common credit myths that many teens (and even some adults) believe and reveal the truth behind them.
Key Takeaways:
• Start building credit early: Good credit provides advantages for future financial milestones and takes time to establish.
• Pay credit card balances in full: Carrying a balance doesn’t help build credit and can lead to unnecessary debt.
• Monitor credit regularly: Checking your own credit doesn’t lower your score and helps catch errors or fraud early.
• Understand credit scoring factors: Focus on payment history, credit utilization, length of credit history, and new credit applications.
• Use credit responsibly: Keeping utilization low, paying on time, and being selective about new credit are key to good credit health.
• Educate on credit safety: Teach teens about identity theft, fraud protection, and the importance of emergency funds to avoid credit reliance.
Myths and Facts
Myth 1: “Teens don’t need to worry about their credit score.”
This couldn’t be further from the truth. While it’s true that many teens don’t have a credit history yet, building good credit early can provide significant advantages. A credit score isn’t just about credit cards; it can affect your teen’s ability to rent an apartment, secure a car loan, or even land a job in the future. Encouraging your teen to start building credit responsibly, perhaps with a student credit card or by becoming an authorized user on your account, can give them a head start on their financial journey.
The reality is that credit scores are based on a person’s credit history, which takes time to build. By starting early, teens can establish a positive credit history that will benefit them in adulthood. It’s important to note that credit scores are calculated using information from credit reports, which are maintained by the three major credit bureaus: Equifax, Experian, and TransUnion.
Parents can help their teens understand that good credit is built over time through responsible financial behavior. This includes paying bills on time, keeping credit card balances low, and avoiding excessive applications for new credit. Parents can help their teens lay the groundwork for a strong financial future by instilling these habits early.
Myth 2: “Carrying a balance on a credit card helps build credit.”
This is a dangerous myth that can lead to unnecessary debt. Credit card companies and credit bureaus don’t give extra points for carrying a balance. The best way to build credit is to use credit cards responsibly by making purchases and paying off the balance in full each month. This approach demonstrates responsible credit use without incurring interest charges.
Many people believe that carrying a balance shows the credit card issuer that you’re using the card and, therefore, helps build credit. However, your payment history and credit utilization rate matter to credit scoring models. Payment history is about 35% of your FICO score, the most widely used credit scoring model. Paying your credit card balance in full and on time each month is one of the best ways to build a positive payment history.
Credit utilization, which is the amount of credit you’re using compared to your credit limits, accounts for about 30% of your FICO score. Keeping your utilization rate low (ideally below 30%) is beneficial for your credit score. Carrying a balance often leads to higher utilization rates, which can negatively impact your score.
It’s also worth noting that carrying a balance means paying interest on your purchases, which can be quite high on credit cards. This unnecessary expense doesn’t contribute to building credit and can lead to a cycle of debt that’s difficult to break.
Myth 3: “Checking your credit score lowers it.”
Many teens (and adults) avoid checking their credit score, fearing it will negatively impact their credit. However, checking your own credit report or score is considered a “soft inquiry” and doesn’t affect your credit score. In fact, regularly checking your credit report is a good habit that can help you spot errors or potential fraud early.
It’s important to distinguish between “soft” and “hard” inquiries. Soft inquiries occur when you check your own credit or when a company checks your credit for promotional purposes. These do not affect your credit score. Hard inquiries, on the other hand, occur when a lender checks your credit as part of a lending decision, such as when you apply for a credit card or loan. Too many hard inquiries in a short period can have a small, temporary negative impact on your score.
The Fair Credit Reporting Act entitles consumers to one free credit report from each of the three major credit bureaus every 12 months. Taking advantage of this can help you stay on top of your credit health without any negative consequences. Many credit card issuers and financial institutions also offer free credit score monitoring services, which can be a helpful tool for tracking your credit over time.
Myth 4: “Debit cards help build credit.”
While debit cards are a great tool for managing money, they don’t help build credit. Debit card transactions aren’t reported to credit bureaus because you’re using your own money, not borrowing. To build credit, teens must use credit products responsibly, such as credit cards or loans, which report to the major credit bureaus.
Debit cards are linked directly to a checking account and function like writing a check or using cash. When you use a debit card, you’re spending money you already have, not borrowing money that needs to be paid back. As a result, debit card usage doesn’t demonstrate your ability to manage credit, which is what credit scores are designed to measure.
However, responsible use of a debit card can indirectly help prepare teens for managing credit in the future. It teaches important financial skills like budgeting, tracking expenses, and avoiding overdrafts, which can translate into responsible credit use when the time comes.
Secured credit cards can be a good starting point for teens looking to build credit. These cards require a cash deposit that typically serves as the credit limit, reducing the risk for both the teen and the card issuer. As the teen uses the card responsibly and makes on-time payments, they can build a positive credit history.
Myth 5: “You only have one credit score.”
This is a common misconception. In reality, multiple credit scores are calculated using different scoring models and data from various credit reporting agencies. The most commonly used are FICO and VantageScore, but even within these, there are different versions. When applying for credit, knowing which score a particular lender uses is helpful.
FICO, for instance, has multiple versions of its scoring model, including industry-specific scores for auto lending and credit cards. VantageScore, a competitor to FICO, also has different versions. Adding to the complexity, each of the three major credit bureaus may have slightly different information in their reports, leading to variations in scores even when using the same scoring model.
This multiplicity of scores doesn’t mean one score is more “correct” than others. These scores aim to predict the likelihood that a person will repay borrowed money, using slightly different methods to arrive at that prediction.
For teens and their parents, the key takeaway is not to fixate on a single number but to focus on the factors that generally improve all credit scores: paying bills on time, keeping credit utilization low, maintaining a mix of credit types over time, and applying for new credit sparingly.
Understanding these myths is crucial for parents guiding their teens through the complexities of credit. By debunking these misconceptions, you can help your teen develop healthy credit habits that will serve them well into adulthood.
Bonus Myths About Credit
Bonus 1: Buy Now, Pay Later (BNPL) services don’t affect your credit score.
This myth has gained traction due to the rapid popularity of BNPL services like Affirm, Klarna, Afterpay, and others. Many consumers, especially younger ones, believe using these services is a “credit-free” way to purchase and spread out payments.
The reality is more complex:
- Initially, many BNPL services didn’t report to credit bureaus, which led to the misconception that they had no impact on credit scores.
- However, as these services have evolved, some have begun reporting to credit bureaus. For instance, Affirm reports some loans to Experian.
- Even if a BNPL service doesn’t report to credit bureaus, falling behind on payments could result in the debt being sent to collections, negatively impacting credit scores.
- Some BNPL providers perform a soft credit check when you apply, which doesn’t affect your score, but others might do a hard inquiry, which can temporarily lower your score.
- Using BNPL services frequently could impact your debt-to-income ratio, which lenders consider when you apply for traditional loans or credit cards.
- As of 2024, credit scoring models are evolving to better account for BNPL usage, meaning these services may have a more direct impact on credit scores in the future.
This myth is particularly dangerous because it can lead consumers, especially young adults, to overextend themselves financially under the false belief that using BNPL services excessively or irresponsibly has no long-term consequences.
Consumers must understand that while BNPL can be a useful tool when used responsibly, it is still a form of credit and should be treated with the same caution as traditional credit products.
Bonus 2: Closing a credit card will immediately improve your credit score
This myth is particularly persistent and can lead to counterproductive financial decisions. Here’s why it’s a myth:
1. Credit Utilization: Closing a credit card reduces your total available credit, which can increase your credit utilization ratio if you carry balances on other cards. Credit utilization is a significant factor in credit scoring, and a higher ratio can negatively impact your score.
2. Length of Credit History: If the card you’re closing is one of your older accounts, it could shorten your average length of credit history when it eventually falls off your credit report (which typically takes about 10 years for closed accounts in good standing). Length of credit history is another important factor in credit scoring.
3. Credit Mix: If the card you’re closing is your only credit card, it could negatively affect your credit mix, which is a minor factor in credit scoring.
4. Short-term Impact: In some cases, closing a card might cause a small, short-term dip in your credit score due to the changes in your credit profile.
5. Existing Debt: Closing a card doesn’t eliminate any existing debt on that card. You’re still responsible for paying off the balance.
The reality is that closing a credit card rarely improves your credit score, and in many cases, it can lower your score, at least in the short term. It’s generally better to keep credit cards open, especially if they have no annual fee, and use them responsibly if you’re trying to avoid temptation.
This myth likely persists because people associate closing a card with reducing their debt or simplifying their finances, which they assume would positively impact their credit. However, credit scoring models are more concerned with how you use your available credit rather than how much you have.
Checking Your Own Credit
Beyond these myths, there are several other important aspects of credit that parents should discuss with their teens:
1. The importance of the credit utilization rate is the ratio of your credit card balances to your credit limits. Keeping this rate low (ideally below 30%) can positively impact your credit score. Teach your teen to view their credit limit not as a spending target but as a maximum; they should stay well below.
2. The impact of length of credit history: Credit scoring models consider how long you’ve had credit accounts. This is why starting to build credit responsibly as a teen can be advantageous – it establishes a longer credit history by the time it’s needed for major purchases like a car or a home.
3. The effect of new credit applications: Each time you apply for credit, it typically results in a hard inquiry on your credit report. Too many of these in a short period can lower your credit score. Teach your teen to be selective about credit applications and to avoid applying for multiple cards in a short time frame.
4. The concept of a credit mix: Credit scoring models like to see that you can handle different types of credit responsibly. While this isn’t something teens need to worry about immediately, understanding that there are different types of credit (revolving credit like credit cards, and installment credit like car loans) can help them plan for the future.
5. The importance of reviewing credit reports for errors: Mistakes on credit reports are not uncommon, and they can negatively impact credit scores. Teaching your teen to regularly review their credit report and dispute any errors is an important financial habit.
6. The role of credit in overall financial health: While a good credit score is important, it’s just one aspect of financial well being. Encourage your teen to also focus on saving, budgeting, and setting financial goals.
Misconception with Credit
Remember, the key to good credit isn’t shrouded in mystery. It’s about using credit responsibly, paying bills on time, keeping credit utilization low, and regularly checking your credit report for accuracy. By teaching your teens these principles and helping them understand the truth behind common credit myths, you’re setting them up for financial success.
As you navigate this journey with your teen, consider exploring resources on financial literacy together. Many credit unions and financial institutions offer educational materials specifically designed for young adults learning about credit. The Consumer Financial Protection Bureau also provides valuable information to help families understand and manage credit responsibly.
Credit Misuse That Can Hurt your Credit Score
It’s also worth discussing the potential pitfalls of credit misuse. While credit cards can be a great tool for building credit and managing finances, they can also lead to debt if not used responsibly. Teach your teen about the high interest rates often associated with credit cards and the importance of paying more than the minimum monthly payment to avoid accumulating interest.
Teen Credit Card Safety
Another important topic to cover is identity theft and credit fraud. In today’s digital age, teens must understand how to protect their personal and financial information. Teach them the importance of strong, unique passwords, the risks of online sharing of financial information, and how to spot potential scams.
As your teen begins to use credit, encourage them to set up account alerts and use mobile banking apps to track their spending and payments. Many card issuers offer tools to help users stay on top of their accounts and avoid missed payments or overspending.
Discussing the concept of emergency funds with your teen is also beneficial. While credit cards can be used in emergencies, having a savings buffer is a more financially sound approach. Encourage your teen to set aside some money each month for unexpected expenses, reducing the likelihood they’ll need to rely on credit in a pinch.
Lastly, it’s important to lead by example. Your teen is likely to emulate your financial habits, so demonstrating responsible credit use and open communication about finances can have a lasting impact on their financial behavior.
Conclusion
In conclusion, don’t let myths about teen credit hold your child back from building a solid financial future. By understanding the facts and guiding your teen towards responsible credit use, you’re giving them the tools they need to navigate the complex world of personal finance confidently. Remember, when it comes to credit, knowledge truly is power!
Building good credit is a journey, not a destination. It requires consistent, responsible behavior over time. By starting this journey during the teen years, parents can help their children establish a solid financial foundation to serve them well. With patience, education, and practice, teens can learn to use credit to achieve their financial goals rather than falling into the traps that lead to financial struggles.
Teen Credit Myths FAQ
1. What are common Credit Myths that teens should be aware of?
Teens should be aware of various myths surrounding credit, such as credit card myths and misconceptions like 5 credit affecting your credit score.
2. How does using a credit card affect your credit score?
Using a credit card responsibly by making timely payments and keeping credit utilization low can build your credit over time and improve your credit score.
3. Can having a debit card help build credit for teens?
No, having a debit card does not directly impact your credit score or history, as it is not a form of credit.
4. What role do credit bureaus and credit reports play in a teen’s credit?
Credit bureaus compile information to generate credit reports, which are used to calculate your credit score based on your credit history and financial behavior.
5. How can opening new credit card accounts impact a teen’s credit?
Opening multiple new credit card accounts quickly can lower your credit score due to increased credit inquiries.
6. Is it true that closing unused credit card accounts can improve your credit?
Closing unused credit card accounts can hurt your credit as it may decrease your overall available credit and increase your credit utilization rate.
