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How To Teach Your Children About Debt
When most parents teach their children about money it is about saving, giving, getting the best deal and spending. While these are all great things to teach kids, they also need to learn all about debt. Not just to avoid it (which is the ideal of course) but also to figure out how borrowing money works, how it effects a person's life and budget, and the difference between good debt and bad debt. I am not an expert, but I will share with you how we handle borrowing money and debt at our house.
First of all they have to be old enough to understand the concept. Once they hit school age they can grasp more of how money works. At this time I will loan them money, momentarily, to buy a want at the store. They must have money at home for me to loan them money. As soon as we get home I make sure they pay me back. They start learning the concept of getting what they want without paying for it right away, but paying for it later.
Once that is done periodically and they have a good grasp of paying someone back when they borrow then I will start letting them borrow money to buy something even if they don't have the money to pay me back at home. We typically discuss in the store or beforehand how they will pay me back. Things to consider are how much the item costs, what the item is, how much money they currently have towards the item, and when they will get the money to pay you back. Will they get an allowance in a couple of days and can pay you then or do they need to do chores to earn the money over the next week or so? Make them figure out ahead of time how they plan to repay the debt.
By the time a child is ten years old or so they should be able to understand more of how debt works. Explain to them the concept of interest and regular payments. Use real life examples of how debt and the repayment process works. At this point if a child wants to borrow money from me but doesn't have money to pay me back at home, then I will let them borrow money (most of the time) but they have to pay me interest. We usually make the interest 10% of what they are borrowing. This is enough that they rethink sometimes if they really want to borrow money.
You can create debt repayment plans to meet your needs. A child can either work off the debt on a regular basis such as one chore per day or be required to do a certain number of chores by a certain time period. It depends on the age really. My younger ones will just do one chore a day. My older ones will be required to do a set amount by a certain day. Then they have to budget their time and make sure they get it all in.
What do you do if your child does not repay you in money or chores by the deadline? Well, now is the time to teach them about repossession. I take the item they bought if I can, although sometimes they borrow money for edible items or gifts for other people and then that is not an option. If I repossess an item they will get it back when they finally pay me for it, plus interest, if applicable. If I can't repossess it, then they have to pay me more money than originally called for, such as another 10% for being past due or doing an extra chore for being late with their payment.
I don't loan money to my kids every day. Sometimes not even every week. This process I have talked about here is years long. We have been working on this for at least six years and we still have a long way to go. I do not loan money for everything. I have a child who wants to spend every penny he ever has and then some. He has to have a solid plan in place before I will let him borrow money and it has to be on something worthwhile. When we were at the store last week and he desperately wanted more football cards I would not let him borrow money. I told him that purchasing something so frivolous and unneeded was not worth going into debt for. Yes he was upset, but later on the way home he said he was glad I hadn't loaned him the money. I think he gets tired of never having any money.
This might sound like a harsh plan, but what better time to teach someone than when the stakes are low. Would you rather your child go into a little bit of debt with you now or a lot of debt with the credit card company later? Would you rather repossess (temporarily) a favorite toy or have the car company repossess their car? The earlier a person can learn a lesson (this goes for anyone) the longer they can use that information to better their life. I really wish I had learned these life lessons when I was a kid. Hopefully by working through this process while they are still living under my roof will prevent them from making stupid mistakes when they are older.