A version of this article originally appeared on Learnvest.com.
Teaching credit is a little like teaching good manners—you need to have it, and you know when you need it, but it’s hard to explain exactly what it is.
Sarah Cook has built her reputation on teaching parents how to teach their kids about money. She is the founder of RaisingCEOKids.com and co-author of The Parents’ Guide to Raising CEO Kids ($12, amazon.com).
Your kids “are going to be learning by watching you,” Cook says. “Before we actually talk to them about money, they are learning through emotion how money should be respected, how it should be talked about.”
Credit is one of those concepts we teach without realizing. Instead of springing the concept on your children when they get their first credit cards, ease them into their understanding to prevent mistakes (post-college credit card debt, anyone?) down the road. Start with the basic concepts as your child gains an awareness of money in general and move on to the advanced ones as she builds the maturity to understand them.
Lesson 1: What Credit Means
Explaining credit to a child can be tricky. (“Oh, it’s just a three-digit number that can prevent you from getting a good interest rate on your loans.”) But if your child can understand earning, borrowing, and paying money, she can understand the concept of credit. Later, as your child’s understanding grows, you can go into more advanced lessons such as the difference between good and bad debt, why you should never take out loans for more than you can afford or the role of a co-signer.
How to teach it: Cook recommends starting simple, the way she did with her children: “Every place that we borrow money from tells a credit agency about how well we did on paying that money back. Your credit report is like a report card on how well you did on paying everyone back.” For guidance on ways to subtly start teaching kids when they’re still young (starting when they’re toddlers), check out this timeline for teaching kids about credit.
Meanwhile, as more advanced concepts come up in everyday life, explain them in context. For example, if you’re trusting your teenager with a credit card for emergencies, whip out the statement to explain the role of interest and why you pay your statements in full, rather than just opting for the minimums. If she’s learning to drive and asking about a car, talk about how people without credit often need co-signers, and explain the responsibilities of that role.
Lesson 2: How Credit Affects Their Lives
Be sure to explain how credit affects your lifestyle. Cook advises explaining how the car you drive, the house you live in, and the job you have can all be affected by your credit score. “It’s important that children understand that credit can be used as a tool. It gives you power and more cash flow, but it also can be a stumbling block if used incorrectly.”
How to teach it: Children begin to notice the differences between lifestyles in elementary school (why is Steve’s house so much smaller than Joseph’s?), so that’s a good time to discuss, gently, why some people have more access to money than others. By middle school, you can be more detailed, explaining the process of buying a car or a house, including the role credit plays in the process.
Teachable moments will occur during normal family conversations about money, too: Is she asking for her allowance early? Does she want you to front the money for a treat because she already spent her birthday cash? That’s a perfect time to discuss how credit can increase cash flow but has to be paid back…with interest.
Lesson 3: How to Monitor a Credit Score
“The way you teach finance is to embrace everyday conversations. When you’re at the grocery store. When you’re at the bank. When you’re paying bills,” Cook explains. “Include your kids in everyday financial transactions so they feel comfortable around money.” In other words, they’ll learn what they see. We should all be checking our credit score regularly—we recommend you do it once every quarter, or four times a year—so you’ll want to model that behavior.
How to teach it: When you’re monitoring your own credit, show them how you access each agency’s reports and what you’re looking for. Don’t be afraid to discuss the items on your report. If there is something negative, talk about where the debt came from and what you’re doing to take care of it. If there is something unexpected or incorrect, explain that, too.
Lesson 4: How to Protect Private Information
Identity theft is one of the fastest-growing crimes today. Cleaning up the damage done by identity thieves can take years, and your credit can get hurt massively. Teach your children to protect their personal information from an early age.
By middle school, kids should understand various ways identity thieves can trick victims into giving up information (an email from a Nigerian prince is never legit) and how they can avoid the traps. By high school, they should start memorizing their Social Security numbers and know only to give it to reputable sources.
How to teach it: As children learn defining information (address, phone number and eventually that Social Security number) discuss who can and can’t have that information. When she starts throwing around her Social Security number on college applications, it’s important to draw the parallel between how unauthorized use of that number, much like unauthorized use of your credit card number, can cause big trouble.
Lesson 5: Not All Debts Are on a Credit Report
The average time for debts to fall off a credit report is seven years, while bankruptcies and other types of debts can take even longer to roll off. What’s more, not seeing a debt on your credit report doesn’t necessarily mean you don’t owe money.
Not all debts are reported in the first place; it’s up to the creditor to provide that information to the credit reporting agencies it chooses. That means one agency may have the debt recorded but another one may not. Secondly, while seven years is a long time, it doesn’t necessarily clear the debt. Depending on the laws, creditors can still come after you in the court system for money owed.
How to teach it: Use your own credit report as a visual aid. Talk about your plans to pay debts, and let older kids help you calculate how long it would take debts to roll off, constantly reiterating the fact that you would still owe the money even if the debt disappeared from the report (and that you intend to pay it off, rather than waiting for it to disappear!). This is also a great time to discuss good versus bad credit by pointing out entries that have helped you establish a financial identity, such as your mortgage or car loan.