How to Teach Your Kids About Debt
By Ann Lloyd
When you’re young, you think you’re invincible, and that can apply to money, too. After all, teenagers don’t have many real-world expenses, so they can buy what they want. When it comes to what they need, parents have that covered.
But when you’re the parents, you know better. You know that the most important thing to buy won’t be the latest video game or a fresh pair of Nikes. You’ll have to save up for a house, a car, or an emergency. You can’t pay for things like that with an allowance, so you’ll need to save up instead. And if you spend too much on impulsive purchases now, you won’t have money for those major investments down the road. Worse, you could put yourself so far in a hole with debt that you struggle to pay it back and hurt your credit for the long term.
As a parent, you never want your kids to make the same mistakes you may have made. Here are a few good ways to teach your kids about debt.
Teach them what credit is… and what it isn’t. Put simply, credit gives you a way to purchase something you want or need now, and pay for it later. To a child, teen, or young adult, credit can seem like “free money.”
Credit allows you to get the item you’re purchasing before you pay for it, removing the immediate incentive to make your payment. That’s why it’s important to teach your child that credit is an asset, and you should be just as protective of it as you are with your cash.
It may help to explain how, in the “old days,” customers would do the opposite in order to afford items they couldn’t pay for right away. They’d make payments over time, but they wouldn’t get what they were buying until after they’d paid in full. It’s called layaway: a method you can use to reserve something you know you want and can pick up when you’ve paid for it. Since you don’t have it yet, you have an obvious incentive to keep up your payments.
Teach your child to stay out of debt by saving for items in advance. Help them set up a layaway plan for large purchases by breaking down the cost of the item into a certain number of payments over a specific period of time. Help them set up a savings account where they can deposit their funds each week or month until they reach their goal. Then, when they reach their goal, celebrate with them.
Let them know why you need credit. Credit can sound pretty dangerous, given the temptation to use it the wrong way and how easy it is to fall into debt. So your kids may not understand why you would even bother using credit at all. Why not just pay for everything upfront? Make sure they know that there will almost certainly be times when you can’t, and that’s okay.
Most people don’t have enough money to pay for a house or car in full, so you need good credit to qualify for a loan. Plus, some landlords and employers look at your credit history to find out whether you’re dependable, so it’s important to be in good standing.
Teach your child the difference between “good debt” and “bad debt,” and make sure they know that paying your bills on time is an important part of building good credit. To do this, consider funding a purchase and allowing them to pay you back over time. Set up a payment schedule, establish late fees, and talk about the consequences if they don’t hold up their end of the bargain. Will you repossess the item? Will you be likely to lend to them again?
Tell them how interest rates work. Establishing good credit when you’re young can help you save money on things you have to pay for over time by helping you get the best interest rates. For that reason, it’s a good idea to teach your kids how interest works.
Explain that interest can work both ways: You can earn interest through a savings account or investments, and you usually pay interest on money you’ve borrowed. Whether you pay a little or a lot depends on your credit history. For instance, if you’re looking to buy a home, and you have excellent credit, you’ll pay thousands—or even tens of thousands—of dollars less over the course of a 30-year mortgage than you would if you had ordinary credit.
This is a complex concept for many young people, but there are online tools you can use to make it easier to understand. Playing games is a great way to make learning about personal finance fun.
Ann Lloyd is a writer for Student Savings Guide, studentsavingsguide.com.