Building credit is an essential step toward financial independence and stability. A high credit score can help you buy a house, buy a car, rent an apartment, and even help you apply for insurance. However, due to the Credit CARD Act of 2009, individuals who are under 21 may find it difficult to open lines of credit. According to this act, no one under the age of 21 can open a credit card account unless certain requirements are met.
Without a credit history, young adults may face challenges in being approved for credit down the line. These teens may experience approval issues when applying for a mortgage, car loan, or even an apartment lease when they reach the proper age. Perhaps worse, even if they do get approved, interest rates will likely be much higher, costing them thousands.
Fortunately, there are strategies and options available specifically tailored to help those under 21 build credit responsibly. By understanding the process and exploring suitable avenues, young individuals can lay a solid foundation for their financial future. Below are 3 ways teens can start using and building credit.
1. Apply for a Credit Card using Proof of Income (Ages 18-21)
According to the Credit CARD Act of 2009, individuals who are under the age of 18 cannot enter into credit agreements. Additionally, individuals under 21 cannot open a credit card unless they met certain restrictions, one of them being proof of income.
If you can prove you have an independent income, you may be approved for a credit card. The exact amount you need is not specified by law, but it has to be enough to independently (without the help of parents/adults) make the minimum payments on the account. For example, young adults who enter the workforce or get a full-time job right out of high school might qualify.
2. Apply for a Credit Card using a Co-Signer (Ages 18-21)
Many credit companies will allow teens and young adults to apply with a co-signer. A co-signer is someone who guarantees that they will pay your credit balance if the teen does not. This is usually a responsible adult with good credit and independent income, like a parent for example. This co-singing option can also work on larger purchases, such as a car, in addition to credit cards. The credit company limits its risk by bringing responsible credit users with good credit history into the deal.
A note about Co-Signing: If you are the person that is co-signing for someone else, make sure you trust them completely! This is a legal contract that states if the borrower fails to pay, you are on the hook for their bills.
3. Become an Authorized User on a Responsible Adults Credit Card (Ages 14-18)
Again, individuals who are under the age of 18 cannot enter into credit agreements. However, many card issuers allow minors to be added as authorized users. This means that the teen can be added to the parent/adult account. The account number would be shared between the two, and the teen would have their own card.
This is a really powerful strategy as it allows the teen to piggyback off the established credit history and responsible use of the primary card holder. By adding the teen as an authorized user, the length of credit (how long this card has been open) and the payment history (paying the bill on time) of this card will now appear on the teen's credit report. Given that we know payment history factors 35% and length of credit history factors 15% into credit score calculations, this can be a really powerful strategy to have the teen start on the right foot.
Additionally, in this situation, the parents are ultimately responsible for the bill. Even though the teen technically has their own card, the bill will come to the primary card holder. This allows parents to monitor their child's credit activity and see what charges were made.
Tip: Use Secured Credit Cards and Student Credit Cards to Start!
In situations 1 and 2, the bill will be the responsibility of the teenager. In situation 3, the bill is the responsibility of the adult. Either way, the payments of this new account will greatly affect the teen's credit score. Make sure all parties understand the implications and are prepared to pay the bill on time (and hopefully in full) each month.
A recommendation from many financial advisors is for teens to begin by opening a student or secured credit card (assuming they meet one of the requirements discussed above).
These types of cards are specifically designed to help individuals build credit and take on less risk. They allow users to experience and get practice using credit but have some fail safes in place to prevent big losses. If you are under 21 or have a low credit score, opening a secured credit card is one of the best ways to grow your history and score!
Final Thoughts
It is important for teens to educate themselves on proper credit usage. Building credit as a teenager not only opens doors to future financial opportunities, such as obtaining favorable interest rates on loans or securing a lease for an apartment, but it also fosters responsible financial habits that will benefit them throughout their lives. By starting early and making smart financial choices, teenagers can lay the foundation for a strong credit history and set themselves up for a more secure and prosperous future.
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