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First credit card? How to build credit without the debt

Gail Johnson

You know your kids are growing up when they become fair game for credit card companies. Now's the time to teach them how to manage credit the right way.

"It can be an exciting time when a young person suddenly has access to capital that wasn't there before," says certified financial planner Al Nagy, regional director of Edmonton's Investors Group Financial Services. "They've got to establish good cash-flow habits by knowing how much they have available to spend each month and by not exceeding this."

With Financial Planning Week taking place Nov. 19 to 25, here are some key points to share with your not-so-little ones when it comes to building good credit.

What is good credit, anyway?

"Good credit — aka good debt — is debt that supports cash flow and helps to build wealth long-term," Nagy says. A student loan, for instance, is considered good debt because the education acquired can help you get a higher-paying job down the road.

Another example? "A loan consolidation with a home equity line of credit that reduces high interest payments and includes an RRSP loan would be considered good debt," Nagy says.

Bad debt, on the other hand, means borrowing to buy things that have short-term value.

"Bad debt drains cash flow and is used to purchase items that are disposable or decrease in value," Nagy explains. Going into debt to take off to Mexico during reading week would qualify as an example of bad debt, as would maxing out a credit card to buy luxury items or indulge in a lifestyle you really can't afford.

How can a young person build a healthy credit report?

"Establishing a credit history is very important," Nagy says. "Start by applying for a credit card even for just the lowest credit available. Then use the card to pay for monthly expenses. Be sure to pay off the balance at the end of each month. If you pay a bill just one day late, it will appear on your credit report as a late payment."

That's an important point: a poor credit rating can affect you for years to come. So while responsible borrowing can help build a good credit history, using credit to spend beyond your means can have lasting consequences. Say you want to buy a car or a home, for instance, or even get another credit card. Your applications can fall through if you're not in good standing.

"Don't maximize or exceed your line of credit or credit-card limit," Nagy says. "Every time you apply for credit, it's noted on your credit history, even if you never use it. Each individual can qualify for a certain level of debt so ensure what you have, matches what you need."

What's in a credit score?

The main factors that are used to calculate your score are your payment history, use of available credit, length of credit history, the number of inquiries into your credit standing, and the types of credit you have.

Your payment history includes things like late or missed payments, unpaid debts that were sent to a collection agency, and whether you've declared bankruptcy.

Your score will take a hit if you make late payments, have accounts that have been sent to a collection agency, or withhold payments because of a dispute with the lender, who then reports your payments as late.

How to keep a healthy credit score

Always pay bills on time. If you can't pay the full amount, make the minimum payment at the very least. Small payments can make a big difference in terms of how much interest you're paying and how long it takes to pay off the money borrowed.

If you're having trouble paying a bill, contact the lender to see if a payment plan can be worked out.

Read the terms and conditions of any credit agreement to be sure you understand what you're getting into.