I imagine, from a parent’s perspective, the prospect of co-signing for a son/daughter’s credit card stirs up a number of emotions and thoughts. There could be number of reasons why a young adult might want/need a credit card, from paying their tuition, to purchasing a big ticket item like a second hand car or perhaps to even start a business. Part of the reason a number of parents eventually give in to their son/daughter’s request is because they love them and cannot say no. But reasons such as pursuing an education or starting a business can be very hard to say no to, simply because education and entrepreneurship are skills and traits that almost all parents want for their children. These and similar justifications run through the minds of parents all the time but financial experts caution strongly against parents co-signing loans/credit cards for their children.
While there are many youth who know how to be frugal and may be understanding of how credit cards work, many more will be likely to overextend their limits, miss payments, and leave mom and dad ultimately on the hook for both the payments and the dent in credit scores.
High Costs of Co-Signing
As a co-signor you are essentially agreeing to be fully responsible for payments on charges made on the card. It will not take long for a few bad financial moves on the part of your kid to ruin your own credit history. Lenders now want perfect credit before they would consider a loan to anyone. If parents are still in the market for another house or line of credit for other reasons, any mistakes on their child’s part regarding credit cards can end up costing parents much more than they anticipated. Additionally, poor payment histories or collections will remain on a credit report for years and lenders do not give one iota of thought to who is actually responsible for overdue accounts.
Teaching a Bad Lesson
Many also believe that parents who sign on a credit card for their child are setting a bad example. Kids who have mom and dad do everything for them will never learn to be self-sufficient. They may also be more careless about their credit card spending, especially during the unsupervised college years. If a child knows parents will foot the bill no matter what, they will likely not learn the necessary basics of personal finance. Parents should be working with their kids to teach them how credit works and how important it is later in life. Children who grow into adulthood understanding that credit is a privilege and not a life entitlement may grow into the most financially responsible adults.
Some parents will still co-sign for a child’s credit card and hope that a strict set of spending rules and consequences will help the child to make the right choices. That is certainly an option for different families. For others, alternative plans may be in order.
Here are some options beyond plastic:
Debt Cards – Many can still be used as a credit card for purchases but there is a lesser chance that balances will be overdrawn because the money comes directly from the account. To add extra responsibility to the mix, parents can require that kids put their own money into the joint account from part time jobs and summer jobs so parents are not relied on totally for financial support.
Secured Credit Cards – Secured credit cards are essentially a prepaid credit card where all charges made are deducted from a deposited balance. Many kids can get secured cards before regular credit cards and still build up a good foundation for credit history and score since these types of cards still report back to the credit bureaus. Money must be fronted to activate the card and replenished when funds run low.
Authorized User – On a parent’s credit card account, children can be added as an authorized user. Parents are still ultimately responsible for the credit card payments but the move can help build a credit history for a young adult. If limits are crossed, authorized users can be removed fairly quickly. Some credit card companies will even allow specific restrictions on the authorized user card’s spending.
This post was written by Arjun Rudra, the founder and editor of Investing Thesis: Credits Towards Financial Freedom For more investing insights, interviews with portfolio managers and trading strategies, please consider subscribing to his feed.