Credit: How to establish healthy habits

Michael Jackson may have been worth billions, but in the final years of his life he had a credit rating that was worthless.

His credit health was so bad, in fact, that a security guard had to set up Jackson’s AT&T iPhone account in his own name.

Clearly, arriving at an abhorrent standing with the credit bureau can happen to celebrities just as it can to mere mortals. There’s a lesson in Jackson’s mangled history for parents: start teaching smart credit habits early so that your kids never end up in the kind of credit nightmare that befell the Neverland Ranch.

“Credit cards are a good way to start building a credit history,” says Michelle Michalak, head of financial literacy at Visa Canada. “Parents can use a first-time credit card as a teaching moment so that students understand the benefits of the card, associated interest rates, and the importance of timely payment on balances so they can avoid late payments and over-the-limit fees.”

How young is too young?

So what’s an appropriate age to introduce someone to the world of easy access to credit?

Legally, you can’t get your own credit card until you reach the age of majority in your province or territory.

“Some young adults will be ready for the responsibility of a credit card at the age of majority, while others will not be mature enough,” says financial consultant Robin Taub, author of A Parent’s Guide to Raising Money-Smart Kids.

“You can also get a supplementary card on your parent’s credit card if you are under [age of majority]. Some 16-year-olds may be mature, responsible, and trustworthy. You have to know your own kid.

“Whether it’s appropriate depends on what it is being used for and whether the young adult truly understands how credit cards work and is ready for the responsibility,” she adds. “If used responsibly, you can start to build your credit history and credit rating.”

Unlike a co-applicant, an authorized user on a card has no liability for any balances, fees, or interest owing on the account. That means parents have to keep a close eye on how much their kids are spending.

“If it’s a supplementary card, the parents will be stuck paying off the balance if the kid goes nuts spending and can’t pay it off,” Taub says.

“If it’s their own card, the young adult could damage their credit rating if they miss or make late payments,” she notes. “They will also incur significant interest if they only make the minimum payment because they have overspent. Either way, it’s a worry for parents.”

To get young people into smart use of credit, start by teaching them the basics.

“If they aren’t informed, they’re likely to make expensive mistakes,” Taub says.

Some of the key features to familiarize young people with, according to Practical Money Skills Canada, include:

• Annual Percentage Rates (APRs) and whether rates are fixed or variable

• Annual, late, and over-limit fees

• Credit limit

• Grace periods before interest kicks in

• Rewards such as airline miles, groceries, or cash back

The tech-savvy generation will also benefit from looking into whether their credit-card issuers offer free, personalized, and automatic alerts via text messages and emails. These can help track things like available credit, balances, payment due dates, purchase activity and payment history.

Teach them how to pay bills online, too.

Price vs cost

It helps to get a clear sense of the cost of using credit, too. Show youth what it looks like to charge a certain amount on a card and what the true cost is using different interest rates.

For instance, using an interest rate of 15 per cent on a purchase of $1,000, and making only minimum monthly payments of $40, it will take someone 31 months to pay off the purchase and cost him $207 in interest alone.

Change that interest rate to 25 per cent and it will take 36 months to pay off the purchase, spending an additional $427 on interest.

To get young people used to the idea of credit cards, Taub suggests starting off by using the card for emergencies only — maybe a cab ride home after a party, for instance.

“Keep the limit low so they can’t get into too much trouble,” she says. “Let them get comfortable with the cycle of spending and then paying off the entire balance on time. Obviously they need some kind of income to be able to finance their purchases. This will be manageable if the card is used only for emergencies or for basics like gas for the car and groceries.

Many financial experts suggest that credit-card users of all ages follow the 20-10 rule to avoid borrowing more than you can afford. Never borrow more than 20 per cent of your yearly net income (not including your housing or mortgage debt); monthly payments should not exceed 10 per cent of your monthly net income.