Teaching your kids how to borrow money may not seem like a wise approach to instilling sage financial habits. However, teaching your kids how to get out of debt is a valuable money management skill, and a lesson better learned at home than with a credit card company.
Occasionally letting your kids borrow money from you is a sound way to illustrate the benefits of staying debt-free.
Here are a few pointers to consider when initiating a loan to your child:
Only allow your kids to borrow for things that you support as a parent.
Don’t let the amount be too much.
- Ideally, limit it to an amount that can be paid off in a few months.
- Review your kid’s budget to make sure payments are affordable.
Create a repayment schedule at the beginning of the loan and have your kid sign it, formally taking out a loan with you as the lender.
Update the loan repayment schedule with every payment and provide them with a current loan balance statement.
Make your kid pay you in cash from their allowance or earnings. Don’t just deduct it from their allowance: they need the experience of transacting the payment.
Charging interest is optional. The experience of repaying the loan balance alone is typically a worthy enough lesson.
If your kid misses a payment, notify them and ask for payment.
- If they don’t pay you, assess an interest charge.
- If they still don’t pay you, reduce or stop their allowance to ‘foreclose’ on the loan.
By your kids’ late teen years, explain that real-life loans include interest charges, and that the rates on credit cards can be high (20% or higher).
- Give some examples of how that impacts loan repayments, the total amount borrowed versus repaid, and finances that remain available for everyday expenses.
- Be sure to explain that people never get out of debt by only making the minimum payments on a credit card.