How teens should break into credit

How teens should break into credit

Establishing credit is an increasingly important step on the road to adulthood, but if done irresponsibly, it can be the financial equivalent of drunken driving.

Credit is seen as so risky that Congress passed a law that will restrict the marketing and issuance of credit to people younger than 21 starting in February.

Yet without a strong credit score, young adults could have a tough time getting a loan, renting an apartment, landing certain jobs or getting cheap insurance in some states.

So what's the best way for teens or college students to build credit?

One option is to add the young person as an authorized user on a parent's credit card account in good standing. The child gets a card in his or her name and inherits the account's history, good or bad.

"It's like a credit card with training wheels," says John Ulzheimer, president of consumer education for

Normally, you need a credit account open for six months before you generate a FICO score, the leading credit score.

The longer the account is open and handled responsibly, the more it adds to your credit score.

However, if you become an authorized user on an account that has been open for 10 years, for example, the account's entire 10-year history will be immediately added to your credit file and count toward your credit score.

During the housing boom, this loophole was abused.

Some people with bad credit paid people with good credit to add them as authorized users on their nice clean accounts so the bad-credit people could get loans.

FICO planned to crack down on this scam in the newest version of its scoring formula by removing authorized users from credit histories. It backtracked at the request of lenders who felt that removing authorized users from credit scoring would make it harder to comply with a federal credit law.

So it left authorized users in the scoring formula but incorporated a piece of logic designed to prevent abuse, says FICO spokesman Barry Paperno.

Parents should put their child on an account with a perfect payment history. If they are all perfect, "pick the one with the longest history and the highest limit so you have the lowest utilization rate," Paperno says.

Unlike joint owners of an account, authorized users are not legally responsible for the debt. If the child runs amok, he or she can be removed from the account.

One downside is that if the parent is paying all the bills, the child is not learning responsible credit behavior. One solution is to make sure the child reimburses the parent for his share of the bill on time.

Another is to make the child responsible for another bill — such as a cell phone or Internet service. If he's late, he might have to pay a late fee or lose service, "but it's not so bad it trashes your credit," Ulzheimer says.

If the parent lacks good credit or does not want to add an authorized user, another option for young adults is getting a secured credit card. The consumer puts an amount in a bank account that secures the card and gets a credit limit in the same amount.

"The purpose is to rebuild or establish credit and then be done with it," Ulzheimer says.

Make sure the bank will report your payment history to all three credit bureaus. Then make sure you pay it on time because it will affect your credit score exactly like any standard credit card.

Secured-card fees vary widely and can be stiff, so be sure to shop around.

As a parent, the most important thing "is to know your children and take an active interest," says Linda Sherry, a spokeswoman for Consumer Action. "Make sure as you are bringing your kids up you let them know (credit) is not free money and that if they don't repay it, horrible things will happen."

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