How to Talk to Your Teen About Credit Cards

The Squeeze 

• Credit cards can seem like magical free money to a young person inexperienced with personal finance. It's up to you to explain how credit works — they’ll thank you later. 
•  Students under 21 are prohibited from getting credit cards unless they have income or a co-signer who helps the applicant build credit. This is a federal law meant to protect young people from getting in over their head with debt.
• Advise your child never to max out credit cards. The ideal credit use ratio (both for credit score and for moderation) is 30% of available credit or less.

Ahhh, credit cards, that shiny piece of plastic that offers an easy and convenient way to buy. At first glance, a credit card might seem too convenient to a young person. After all, who wouldn’t want instant “free money” at their fingertips? 

With great power, however, comes great responsibility. That’s why it’s critical to talk about responsible credit card use to your teen. Here’s how to answer their burning questions about credit.

How does a credit card work?

If your teen already has experience with a debit card, it’s time to clarify how credit cards differ. The key difference, of course, is that with each swipe, you’re borrowing money rather than using your own money directly from your checking account. This is known as revolving credit, which means you can borrow money from a bank up to a credit limit, and the loan "revolves" monthly (meaning interest is added for any carried-over debt). The credit limit will depend on a variety of factors, including your income and other debts. 

Some credit cards offer special perks like sign-up bonuses, cash-back offers and airline miles, which add to a credit card's appeal. Teach your children to understand that the perks rarely outweigh the cost of carrying debt, and to be cautious about being wooed. 

On the positive side, credit cards typically provide better consumer protection against fraud than a debit card. That’s because the card issuer wants to get back the money it lent you and, therefore, will make more of an effort to resolve the fraud. And of course, credit cards are useful for paying for large purchases across a number of months. But advise your child to actually map out their intended repayment plan for that sofa or big-screen TV, committing to pay it in three months or six months, and not use the credit card for meals out and such while paying off that purchase. Otherwise, it's easy to start piling on debt and get behind.

How do you pay back credit?

Explain to your child that when you get your monthly credit card bill, you’ll have three options: paying a minimum amount, paying the total balance, or paying some amount in between. Point out that paying the total balance each month costs nothing at all — in this way you are using the credit card as a free convenience service, allowing you to buy what you need and pay for it all at once. 

The flip side is paying only the minimum, which can be tempting. But it's critical your teen understands the accelerating power of compound interest — interest that collects on both your purchase and any unpaid interest, month after month and day after day. In fact, interest is calculated daily on credit card balances after the 30-day grace period. So a $1,000 sound system can end up costing $1,692 if only a minimum payment of $22 is made each month: that means paying a whopping 40 percent more than your purchase price. 

The best plan for credit cards is to have a plan as to how you will use them, and to commit to specific payment habits of paying off in full each month or defining how many months to extend payment for a large purchase across — and stick to it. Teach this valuable lesson to your kid, and tell them to get compound interest working for them, by putting a few dollars away in a savings account each month.

Time is, after all, very much on their side.

What is a credit score?

Your credit score is a three-digit number that tells lenders how risky it would be to give you a loan. The higher, the better: a score at the maximum of 850 is excellent and puts you at very low risk. However, any score over 740 is considered excellent. 

Contrary to what some believe, checking to see your credit score does not lower it. The main factors that affect your credit score are the length of time you’ve used credit and your ability to pay bills on time.

Your credit score influences the types of credit cards you’re eligible for. For the most part, people with excellent credit can get credit cards with rewards, while people with average credit scores can get cards that offer rewards for a fee. People with bad credit often only qualify for secured credit cards, which usually lack rewards and require a security deposit that you receive after closing the account or switching to a regular unsecured card.

What fees will I have to pay?

It depends mainly on the credit card you’re using, but virtually all credit card issuers charge some sort of interest.

If you don’t pay your credit card bill in full every month, you will start to accrue interest. Interest rates (also known as Annual Percentage Rates, or APRs) vary between purchases, balance transfers, and cash advances.

Some credit cards require annual fees, which can range from $20 to hundreds of dollars. Avoid credit cards that charge very large annual fees without perks and rewards in return. Make sure you’re getting your money’s worth.

Late-payment fees vary by card issuer. As of 2020, the most a card issuer can charge you under federal law for your first-time late fee is $29. Late fees also can never exceed the minimum payment due.

Balance transfer fees are generally 3 percent to 5 percent of the amount of debt transferred. Some card issuers will waive the fee if you perform the transfer within a specified time frame.

Some card issuers charge foreign transfer fees if you make a transaction with a non-American merchant. They are typically not charged by travel credit cards.

Can I get a student credit card?

Yes, but you’ll likely need a co-signer. The Credit Card Act of 2009 prohibits students under 21 from receiving credit cards unless they have income or a co-signer who helps the applicant build credit. Not all issuers allow co-signers.

Credit cards can seem confusing, especially to a young person inexperienced with personal finance, but they don’t have to be. Keep your teen informed about responsible credit card use now, and they’ll thank you later.