As if parents of teenagers didn't have enough tough decisions to make, another one is coming: Should you get your kid a credit card?
Starting in February, people under age 21 likely will have a much harder time getting approved for plastic as reforms enacted by the Credit Card Accountability, Responsibility and Disclosure Act of 2009 go into effect. Applicants under 21 will have to prove they have "independent means" to repay their debts -- that is, jobs -- or they'll have to get adults to co-sign for their cards.
I'm a fan of this change, which I think was long overdue, as I argued in "Teens need debt driver's licenses." People under 21 are often abominably bad at managing their credit and frequently take on potentially life-altering amounts of debt without understanding the consequences.
Need proof? Just check out a recent Sallie Mae study that reports on undergraduates' use of credit. Of the 84% of college students who have at least one credit card:
- A whopping 82% carry balances.
- The median debt owed has grown 74% since 2004.
- Eighty-four percent of the students said they needed more education on financial-management topics.
Clearly, college students aren't getting the message that carrying credit card debt is stupid. Maybe that's because too many of their parents haven't learned that lesson or at least have failed to communicate it.
How parents can help
"What a horrible job we as parents have done teaching financial management," said Bill Hardekopf, the CEO of credit card comparison site LowCards.com, after reviewing the Sallie Mae statistics. "(Students) share some of the blame, but to me it's an indictment of us as parents."More from MSN Money
Video: New rules for credit cards on campus
Reform puts the ball squarely back in the parents' court. But do you co-sign and put your own credit at risk? Or do you refuse, perhaps leaving your child at a disadvantage in the post-college world when he or she will need good credit to get an apartment or a car loan?
The answer depends both you and your child. As with so much else in parenting, what works for one family might be a disaster for another.
Here's what both you and your teenager need to know:
- Good credit is essential these days. A solid credit history and good credit scores will do more than help someone get a decent rate on a car loan or mortgage. Landlords, employers and insurance companies all use credit histories to evaluate applicants.
- Mistakes will haunt you. A single skipped credit card payment can knock up to 100 points off your scores and can stay on your credit reports for seven years (although the impact of the delinquency will fade over time if you get your financial act together). The more times you're late, the greater the accumulated damage.
- Credit cards should be paid off in full. Credit cards require you to pay only a fraction of what you owe every month, but only suckers play that game. Carrying a balance means you incur unnecessary finance charges and leaves you at the mercy of credit card issuers who can change the rules with little notice.
- You shouldn't use more than a fraction of your limit. Even if you're paying in full, you should be careful not to use much of your available credit at any point during the month, because coming anywhere close to your limit can hurt your scores. Using half or less of a credit limit is good; 30% or less is better; 10% or less is best.
- Co-signing puts both parties' credit on the line. Creditors hold both parties accountable for the debt, which means a skipped payment will trash both parties' credit scores.
Co-signing might help student learn
Hardekopf wanted his kids to learn these lessons before they went to college. So he and his wife co-signed for credit cards for their three children while they were still in high school. (Two are now college graduates, and the third is an undergraduate.)The kids were responsible for keeping track of their balances and paying off the bills in full and on time, under their parents' watchful eyes.
"We talked them through what a credit limit is, what is a balance, what an APR is and if you miss a payment how expensive it is," Hardekopf said. "They were under our roof so we could train them and make sure they didn't make mistakes."
Actually, the kids did make mistakes -- and learned from them. Hardekopf said the older two each sent in payments a few days past the due dates and were shocked by the late fees and finance charges they had to pay. That motivated them to get future payments in on time, and he said both graduated with good credit scores.
Hardekopf said the arrangement has worked out well for his family, but another credit card expert wasn't comfortable co-signing for a card when his son went off to college this fall.
The case for debit cards
Curtis Arnold, the founder of CardRatings.com and author of "How You Can Profit From Credit Cards," started his son out with a checking account and debit card, which worked all right -- for a while."He used a debit card his whole senior year, but this summer he got lax to the point where he got hit with a few overdrafts," Arnold said. "So he's gone one step back. We've got him on an old-fashioned ATM card, and he can only get cash."
Arnold believes strongly that teenagers need experience using plastic but that they need to work their way up to credit cards after responsibly using debit cards. He's not sure any college freshman, new to handling expenses on his or her own, is quite ready for a credit card.
And he's certainly not willing to put his good credit in a teenager's hands.
"I just don't think I'd be comfortable co-signing," Curtis said. "And I don't know if most parents would take the time to (monitor) the account to make sure it's being used responsibly."
Curtis did, however, give his son one leg up in establishing a credit history: He added the boy as an authorized user on one of his credit cards. Adding someone as an authorized user can help them build a credit history without giving them full access to the account.
Another option for the under-21 set is a secured credit card. These cards require a deposit to open -- one that's typically equal to the credit limit -- and may not require a co-signature even after the new rules kick in. (The deposit may be proof enough the borrower can pay the debt.) Borrowers need to choose a card carefully, however, because some charge egregious fees; look for cards with set-up and other initial fees under $100.
Continued: If you co-sign (or if you don't)
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