Teenager taking out loans to establish good credit

[anonymousboglehead]

Hi everyone!
I'm here using my alternate account again, as I have another question that pertains to my age. I'm 17 and starting college in about three weeks, and my parents have generously agreed to pay out-of-state tuition all four years at the public university I'll be attending (they have had 529 money earmarked for some time, so to my knowledge it won't be jeopardizing their retirement or other savings in any way). While they are set on paying for my education, I've been contemplating taking out a small student loan ($5,000? $10,000?) so that I a). have some skin in the game, b). gain low-stress experience with real-world debt and finance, and c). have a loan that I will be able to pay down gradually to establish good credit once I'm out of college. My plan would be to pay it off myself once I have a job, but I imagine that if something went horribly wrong and I were unable to work, my parents could always pay off the debt before it accumulated a crippling amount of interest or late fees. The loan amount would be small enough that it wouldn't affect my major or career choice, allowing me to maintain the numerous benefits of a fully-funded education. Superficially, it seems like a productive, low-risk way to establish credit, but I'm wondering if any Bogleheads have insight into this scenario. Should my parents pay for 100% of my college, or should I take out a "token" loan? I know this is a very "first world" problem, and it's because I'm extremely grateful to my parents that I want to make the best possible decisions for my financial future. Thanks in advance for your responses; I'll be at this school for (hopefully) the next four years, so I've got some time to figure it out.
Danny

[White Coat Investor]

You don't technically need a credit score to get a mortgage, and that's all you'll ever really need debt for anyway.

But it's pretty easy to get one. When you get a car, get a credit card and just put gas on it. Set it up to autopay out of your bank account at the end of the month. You probably aren't going to spend any more on gas than you would otherwise and you get a credit score out of it. Maybe do the same thing with your cell phone bill on a different credit card. Do that for 1-2 years and your credit score will be just fine for automated underwriting for a mortgage.

I certainly wouldn't take out a $5K loan I didn't need just to build a credit score or get real world experience.

[anonymousboglehead]

You don't technically need a credit score to get a mortgage, and that's all you'll ever really need debt for anyway.

But it's pretty easy to get one. When you get a car, get a credit card and just put gas on it. Set it up to autopay out of your bank account at the end of the month. You probably aren't going to spend any more on gas than you would otherwise and you get a credit score out of it. Maybe do the same thing with your cell phone bill on a different credit card. Do that for 1-2 years and your credit score will be just fine for automated underwriting for a mortgage.

I certainly wouldn't take out a $5K loan I didn't need just to build a credit score or get real world experience.

Got it, thanks for the response! So a large quantity of small charges on a credit card over a period of multiple years would produce a credit score similar to taking out a small student loan and paying it off?

[The Wizard]

Got it, thanks for the response! So a large quantity of small charges on a credit card over a period of multiple years would produce a credit score similar to taking out a small student loan and paying it off?

Yes. They are looking for evidence that you make payments to creditors on a timely basis, never being late.
Secondly, they are looking to see that you don't spend irresponsibly and max out your CCs.
So small charges paid in full each month make you look good...

[munemaker]

Here is a tip: If your parents have good credit and a credit card with a long history, they can make you an authorized user of the card. They do not have to give you the physical card. It will show on your credit report and favorably impact your score.

We did that with our kids, and also they obtained credit cards of their own while teenagers (I think that is harder to do now).

When my youngest son applied for a mortgage, loan officer commented he seldom sees credit scores that high from someone as young as him.

[White Coat Investor]

Here is a tip: If your parents have good credit and a credit card with a long history, they can make you an authorized user of the card. They do not have to give you the physical card. It will show on your credit report and favorably impact your score.

We did that with our kids, and also they obtained credit cards of their own while teenagers (I think that is harder to do now).

When my youngest son applied for a mortgage, loan officer commented he seldom sees credit scores that high from someone as young as him.

Yet another reason why credit scores are a joke...but yes, I'm surprised how few people know this trick and it is even less hassle than my proposed solution. Great post.

[The Wizard]

Here is a tip: If your parents have good credit and a credit card with a long history, they can make you an authorized user of the card. They do not have to give you the physical card. It will show on your credit report and favorably impact your score.

We did that with our kids, and also they obtained credit cards of their own while teenagers (I think that is harder to do now).

When my youngest son applied for a mortgage, loan officer commented he seldom sees credit scores that high from someone as young as him.

Yet another reason why credit scores are a joke...but yes, I'm surprised how few people know this trick and it is even less hassle than my proposed solution. Great post.

The joke part being, apparently that in some cases the teenager charges stuff to the card, but Mom&Dad pay the entire monthly bill, right?

[Longdog]

It's quite likely that you'll be offered a credit card once you start college, even without a credit score. It's the only time in your life that will happen. Take advantage of it, use it for small charges monthly, and pay off IN FULL each month. Don't charge anything that you don't have the cash to pay off.

[anonymousboglehead]

Got it, thanks for the response! So a large quantity of small charges on a credit card over a period of multiple years would produce a credit score similar to taking out a small student loan and paying it off?

Yes. They are looking for evidence that you make payments to creditors on a timely basis, never being late.
Secondly, they are looking to see that you don't spend irresponsibly and max out your CCs.
So small charges paid in full each month make you look good...

Understood. Thanks!

Here is a tip: If your parents have good credit and a credit card with a long history, they can make you an authorized user of the card. They do not have to give you the physical card. It will show on your credit report and favorably impact your score.

We did that with our kids, and also they obtained credit cards of their own while teenagers (I think that is harder to do now).

When my youngest son applied for a mortgage, loan officer commented he seldom sees credit scores that high from someone as young as him.

Great idea. I don't know whether or not my parents have considered this, but I'll bring it up with them.

It's quite likely that you'll be offered a credit card once you start college, even without a credit score. It's the only time in your life that will happen. Take advantage of it, use it for small charges monthly, and pay off IN FULL each month. Don't charge anything that you don't have the cash to pay off.

I'll likely do that as well. Thanks for the help!

[White Coat Investor]

Here is a tip: If your parents have good credit and a credit card with a long history, they can make you an authorized user of the card. They do not have to give you the physical card. It will show on your credit report and favorably impact your score.

We did that with our kids, and also they obtained credit cards of their own while teenagers (I think that is harder to do now).

When my youngest son applied for a mortgage, loan officer commented he seldom sees credit scores that high from someone as young as him.

Yet another reason why credit scores are a joke...but yes, I'm surprised how few people know this trick and it is even less hassle than my proposed solution. Great post.

The joke part being, apparently that in some cases the teenager charges stuff to the card, but Mom&Dad pay the entire monthly bill, right?

No. You don't actually have to give the teen the card or even the account number. You're not giving the teen a card. You're putting them on the account.

The joke is that now this teenager has this 800 credit score despite never having borrowed money and nobody having any idea whether he is a reliable borrower or not.

[hushpuppy]

delete

[itstoomuch]

+1 to everything.
Add, pay the loan monthly and do not let the loan "capitalize" interest.
Our CreditUnion Visa card is 7.5%. Avoid more than 33% of CC capacity. Pay at least minimum payment to avoid capitalization of interest
Open up a checking account. Get a VisaCard. Use checking account pay Visa and student loan.
Ours also had a UGMA brokerage account.
Everything funnelled thru checking account.
Credit Score 820 at graduation, age 21.

[The Wizard]

+1 to everything.
Add, pay the loan monthly and do not let the loan "capitalize" interest.
Our CreditUnion Visa card is 7.5%. Avoid more than 33% of CC capacity. Pay at least minimum payment to avoid capitalization of interest
Open up a checking account. Get a VisaCard. Use checking account pay Visa and student loan.
Ours also had a UGMA brokerage account.
Everything funnelled thru checking account.
Credit Score 820 at graduation, age 21.

Umm, NO, as regards the highlighted part.
Pay CC bills IN FULL each month.
I tend to pay my CC BALANCES in full once or twice a month, before they've even gotten to the closing date for the month...

[NYC_Guy]

+1 to everything.
Add, pay the loan monthly and do not let the loan "capitalize" interest.
Our CreditUnion Visa card is 7.5%. Avoid more than 33% of CC capacity. Pay at least minimum payment to avoid capitalization of interest
Open up a checking account. Get a VisaCard. Use checking account pay Visa and student loan.
Ours also had a UGMA brokerage account.
Everything funnelled thru checking account.
Credit Score 820 at graduation, age 21.

Umm, NO, as regards the highlighted part.
Pay CC bills IN FULL each month.
I tend to pay my CC BALANCES in full once or twice a month, before they've even gotten to the closing date for the month...

I think you misread that. I took that as a suggestion to pay the interest component of the student loans while in school (even if you can defer), rather than choosing to let the student loan interest be capitalized.

[PFInterest]

+1 to what others have said.
definitely do not borrow money for a "credit score".
dont forget you can get a secured CC, just make sure it actually reports to the credit bureaus.

[N10sive]

I like the become an authorized user of a card from your parents.

Possibly your parents could open a rewards card and you could use that for your daily needs and pay off every month. Then you also get cash back/rewards.

Seems like a win/win. Just don't abuse it. I wouldn't recommend a student loan as you would pry get a higher interest rate through a bank.

[camillus]

You can ask your parents to add you as an authorized user for the purpose of establishing your credit, but then ask them to keep the card with your name on it in their sock drawer. It's not a good habit to get into to pay your parents back for things (what are the terms of such a line of credit?). You should try to be as independent as you can.

[anonymousboglehead]

Hi everyone!
so to my knowledge it won't be jeopardizing their retirement or other savings in any way). While they are set on paying for my education, I've been contemplating taking out a small student loan ($5,000? $10,000?) so that I a). have some skin in the game, b). gain low-stress experience with real-world debt and finance, and c). have a loan that I will be able to pay down gradually to establish good credit once I'm out of college. My plan would be to pay it off myself once I have a job, but I imagine that if something went horribly wrong and I were unable to work, my parents could always pay off the debt before it accumulated a crippling amount of interest or late fees. The loan amount would be small enough that it wouldn't affect my major or career choice, allowing me to maintain the numerous benefits of a fully-funded education. Superficially, it seems like a productive, low-risk way to establish credit, but I'm wondering if any Bogleheads have insight into this scenario. Should my parents pay for 100% of my college, or should I take out a "token" loan? I know this is a very "first world" problem, and it's because I'm extremely grateful to my parents that I want to make the best possible decisions for my financial future. Thanks in advance for your responses; I'll be at this school for (hopefully) the next four years, so I've got some time to figure it out.
Danny

I don't have a direct response to the above other than to say you seem an unusually thoughtful person at age 17. But I would like to ask you if you know about the "rule of 72". If you do, please ignore my post.

Roughly speaking the "rule of 72" refers to what happens to a sum of money if compounded at some interest rate. For example a credit card loan at a 18% rate would approximately double after 4 years (72/18 = 4), if no payments were made. $10,000 owed would become $20,000 owed after 4 years. (I understand payments would be made, but please bear with me.) Note that another 4 years with no payment at 18% would result in $40,000 owed. Credit cards often have escalation of the interest rate written in the fine print, so even a 30% rate might be possible in some states. Late fees are usually assessed if minimum payments are not made. Even 9% results in a doubling every 8 years without payments (72/9 = 8). Note that credit card companies love minimum payments. Hopefully, you see why they love that compounding rate.

What I am trying to convey is that credit at relatively high interest rates can be destructive to wealth creation. Mortgage and auto loans are usually necessary. However, I believe it is very useful to a young person less than 120 years old to understand there is an ongoing financial life battle that most people must fight, unless they enjoy "poor" financial outcomes.

Most bogleheads would be ecstatic if they could get a consistent 10% return on their investments. In reality a consistent 10% return is very difficult to achieve. On the other hand furniture stores, credit card companies, jewelry stores and many other businesses often make more financing whatever their customers are buying, than they do on the purchases themselves.

So...the "rule of 72": In my opinion truly understanding the nearly limitless implications is a very worthwhile endeavor. I wish someone had clued me in long ago.

Regards,

hushpuppy

hushpuppy,
I am indeed familiar with the rule of 72, but thank you for reminding me. I understand that taking out an unnecessary loan would cause me to lose money, but I simply wondered if the (likely minimal) costs of a small loan would be offset by possible benefits further down the road. I see now, however, that there are solutions which would allot me the same credit-score benefits without having me lose money.

I like the become an authorized user of a card from your parents.

Possibly your parents could open a rewards card and you could use that for your daily needs and pay off every month. Then you also get cash back/rewards.

Seems like a win/win. Just don't abuse it. I wouldn't recommend a student loan as you would pry get a higher interest rate through a bank.

You can ask your parents to add you as an authorized user for the purpose of establishing your credit, but then ask them to keep the card with your name on it in their sock drawer. It's not a good habit to get into to pay your parents back for things (what are the terms of such a line of credit?). You should try to be as independent as you can.

This seems like the best idea so far. I'll bring it up with them later this week. Thanks for all your help!

[LadyGeek]

...I'm here using my alternate account again, as I have another question that pertains to my age.

I'd like to confirm the OP is using a second account for questions which have a concern for privacy. See:
Usernames (accounts), second paragraph.

[Raymond]

...No. You don't actually have to give the teen the card or even the account number. You're not giving the teen a card. You're putting them on the account.

The joke is that now this teenager has this 800 credit score despite never having borrowed money and nobody having any idea whether he is a reliable borrower or not.

I followed your advice in an earlier thread, and my oldest daughter (college junior) now has a credit score of 803 by being an authorized user on my three credit cards - she has access to only one of the cards, which she uses rarely.

Of course, I had better not screw up her score by missing a payment myself

Thanks for the great advice!

[whomever]

When you get a car, get a credit card and just put gas on it. Set it up to autopay out of your bank account at the end of the month.

I really like that idea. I think that getting in the habit of paying the balance in full every month without fail might be as valuable as the credit score.

You can't live without a credit card these days (e-commerce, hotels, rental cars, ...). In olden (pre credit card) days it was easy to learn to budget - get paid, pay the rent and bills, put some in savings, and for the rest of the month just look at the checkbook balance. The art of saying 'I'll wait for next month's paycheck to buy that' was easy when the checkbook ran dry and transferring from savings meant a trip to the bank during business hours. Nowadays with credit cards that budgeting process takes a little more mental effort. Getting in the habit of paying the bill off every month is a really good habit to develop.

[art_org]

What are the terms of the student loans ...
If they are 0% while in school, take all you can as you can make a nice profit even if you put them into a safe investment (CD's) and they will create a nice emergency fund, this should overcome any up front origination fee ... then as you finish school you will have a choice to pay off or not dependent on the current interest rates and the loan rates ...

[NotWhoYouThink]

Paying rent and utilities also contributes to your credit score. If you live off campus for some of your college career, try to get the lease in your name, and get some of the utilities in your name. People are looking at whether you reliably pay in full and on time.

[takeshi]

You can certainly build credit without incurring debt or paying interest by using credit cards and paying every statement balance in full. There is some scoring benefit to having installments (mortgage, auto loan, student loan, etc) in your Credit Mix but it really doesn't make sense to take on an installment just for scoring purposes. Take one on when you actually need to do so.

Got it, thanks for the response! So a large quantity of small charges on a credit card over a period of multiple years would produce a credit score similar to taking out a small student loan and paying it off?

Not exactly. Credit scoring doesn't quite work like that and there are a lot of intricacies at plat. However, either way you're establishing Payment History. Payment History really isn't about the amounts. It's really about whether a given payment is on time or not. You definitely want your Payment History to be spotless as it is the biggest factor in FICO scoring.

Installments aren't assessed quite the same way as revolvers (credit cards, lines of credit, etc). Paying down credit card balances can yield a scoring increase if it significantly reduces revolving utilization (balance/limit). To some degree, there's a similar benefit to paying down the balance on an installment but it's nowhere near as significant as revolving utilization. If one pays off the only active installment that one has, there is actually a slight hit to Credit Mix.

This link is just a starting point for understanding the different factors involved in FICO scoring:
http://www.myfico.com/credit-education/ ... dit-score/

Paying rent and utilities also contributes to your credit score.

Not with current scoring models widely in use (FICO 8 and earlier). Though being delinquent on these can certainly have an adverse impact on one's credit and scores with models that are currently widely used.

[Carson]

The joke part being, apparently that in some cases the teenager charges stuff to the card, but Mom&Dad pay the entire monthly bill, right?

In DH's case the joke part is that his 'oldest account' on his credit report was opened before he was born.

It was a huge debacle to get that removed from his credit report. We wanted to get it off there b/c his parents were going through a divorce and not making great financial choices. The last thing we needed was him to get dinged for something that wasn't his fault. So remember it works both ways.

To the OP, you've gotten good suggestions in this thread as far as how to develop a bit of a credit history. I got a CC at age 16 and would use it to buy groceries (reimb. by my parents) and probably some tapes from Columbia House I'm glad I have taken care of the card and have retained excellent credit.