My kids are constantly asking for money. When they were little, they wanted candy, toys and computer games. Now, it’s Hollister and Abercrombie and Fitch clothing, data plans and money for the movies.
At some point, they’ll want a car, an education and a house. As such, they’ll need to understand how loans work so they can make wise financial decisions.
Be the Borrower
To teach my kids how loans work, I’ve borrowed small amounts of money from them.
After I knew they had saved some allowance money, I asked to borrow five dollars. I agreed to repay the principle amount plus 10 percent interest in one week.
We made the experience realistic with a formal, written contract that resembles typical bank loan paperwork. It included the principle, interest and repayment amounts as well as the consequences for late payments. I also used a repayment coupon book to add realism to the experience.
The first few times I borrowed money from them, I repaid the loan on time. Eventually, I purposefully defaulted on a loan in order to teach my kids how to calculate compounding interest. With each default, the total loan amount grew and they learned quickly that one missed or late payment can greatly increases the amount of money owed to the lender.
Borrowing money from your kids teaches them about loans firsthand. They also learn what it feels like to be the lender when the borrower does and doesn’t repay the loans. That feeling might help them be conscientious about repaying loans when they’re ready to borrow from the bank.
Be the Lender
Instead of sending my kids to a regular bank, I opened the Bank of Missy. My kids continue to learn how to borrow money wisely, in a safe environment, under my tutelage.
Before lending money, we agree on an amount they can borrow. I don’t talk my kids out of making purchases. They can buy whatever they want. I remind them, though, that the interest payments are higher when they charge more. If they want to have money for future purchases, they can’t charge too much now.
We also discuss the repayment terms. My kids repay the loan with money from their allowances. I also pay them for completing extra jobs, like pressure washing the deck.
I add consequences for paying less than the full amount. An extra fee or loss of a privilege helps my children understand the seriousness of borrowing money.
I recently put this principle to the test. My son wanted to buy a Nintendo 3DS and had a little more than half the money saved.
After I agreed to lend him the money, we calculated the monthly repayment amount and how many months it would take for him to repay the loan. I wrote out a contract and a designed a quick little coupon book. I also set the late payment fee and told him I’d take his new 3DS away for a month, if he missed a payment. If he missed more than two payments, I would repossess it and put it up for sale on eBay. He agreed to the contract, and we both signed it.
My son never missed a payment. He even repaid the loan in full, a month early.
Teaching your kids about loans is part of your responsibility as a parent. When you act as both borrower and lender, you confidently share the ins and outs of consumer loans and give your kids access to the financial wisdom they need for success as adults.