Financial literacy isn't the same thing as common sense. Americans don't have a strong understanding of money, and it shows with poor credit scores, poor cash management and heavy debt loads.
A study done in 2012 by The Organization for Economic Cooperation and Development (OECD) revealed that only 1 in 10 U.S. student scored highly on a financial literacy exam while nearly 18 percent didn't even register as understanding the basics.
It's more important than ever to teach your kids about money and credit to spare them the difficulty of waking up one day and realizing that their finances are spinning out of control. Having a solid grasp on debt, credit, loans and financial products before they even attend college can go a long way and lead to financial success at an earlier age.
Some financial lessons you can start teaching at a very young age, while others might require a higher level of maturity. Regardless, here are the top three things parents can do to help their kids understand credit.
Explain the Idea of Credit
Credit might seem like a complex notion, but there are ways to explain the concept in an easy-to-grasp manner. Credit is like borrowed money that must be paid back with a bit extra in thanks.
If you're out shopping and your child wants something but doesn't have enough money, that's a perfect opportunity to explain what credit is and how it works. Tell him that credit allows him to purchase this toy today, but that he has to pay it back by a certain time with a little extra for interest. If he doesn't want to pay more than the toy is worth, he can wait to buy the toy once he has enough allowance saved.
For a teenager, buying a prepaid debit or credit card for him is the best way to help acquaint him with credit. If he has a job, he can even link the card to his account. Co-signing for a real credit card might be too big of a responsibility at that age — not to mention how nonpayment will affect your credit score should it occur.
Why It Pays Off to Save Up
As anyone with a kid knows, when a child wants something, it has to be right this very second. He could pass by a toy he's never seen before or a snack he wants while you're out and suddenly he needs to have it right then and there, no exceptions. If he doesn't have the money for it, you can bet he'll go straight to the bank of mom and dad. When that happens, you should take the time to explain the cost of buying it now versus saving up for it later.
Explain to him that he can have it now if he wants it, but that he will be borrowing money that needs to be paid back, and that he will actually be paying more for it — thanks to interest — in exchange for getting it now.
Let him decide if it's better to save up money to buy the item later. If explained properly, you might be surprised by what a child chooses.
That a Credit Score Should Be High, Just Like Test Grades
Adults understand what a credit score is and how it affects their lives, but you don't want your child to develop poor money management habits only to discover how important good credit is once rejected for a loan. However, parlaying that information into kid speak can be a challenge.
The best way to go about it is to relate it to a point system. If he's in school, this lesson is much easier to relay. Explain to him that everyone gets awarded points for how well they use their credit. If they use too much, it goes down. If they don't pay on time, it goes down. Let him know that a bad score means that he won't be able to borrow as much money and that he'll have to pay even more interest to do so. A low enough score might mean that he can't buy anything on credit at all.
This can be a good opportunity to explain your own finances with your children. Let them know how your car or house gets bought and paid every month. Explain to them that a good credit score makes it cheaper to do that, while a bad one makes it more expensive and potentially impossible. For the teenager in your household, allowing him to obtain a small credit line, like a gas credit card with a limit of $250, will let him build credit without putting him at serious risk.
Keep reading: 8 Great Books That Teach Kids About Money
Children taught at an early age to understand financial concepts like credit will be able to use critical thinking skills as adults when it comes to money. They'll remember the lessons they were taught as kids, especially if you discuss these concepts on a consistent basis.
Establish a rule that allows your kids to use credit to buy things and assign a scorecard for them. When you make it something that they can actually see with their own eyes, they tend to follow it more closely and understand the concepts better. As they grow up, they will know how to avoid high interest and splurge spending on credit cards. They'll be able to make better decisions when it comes to student loans, and understand that nothing is for free and that anything they use now will have to be paid back later.
This article originally appeared on GoBankingRates.com.