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. Also be sure to explain that people never get out of debt by only making the minimum payments on a credit card.