Getting a car. Starting a business. Buying a family home. For most people, these financial goals are only affordable through borrowing money. So why does debt have such a bad rep? Because not everyone knows how to borrow money the smart way – and this can lead to costly financial mistakes.
That’s why teaching your kids about borrowing from an early age is an important part of their financial education. And when it comes to teaching your kids healthy money habits, borrowing and personal responsibility are two concepts that go hand in hand. Through candid conversations about money management and a little practice, you can help your child gain experience in borrowing and paying back.
How to Teach Your Kids the Basics of Borrowing
There comes a moment in every parent’s life when their child asks for a loan to buy an expensive toy. Before you tell your child to save up for this item or list all the reasons why they don’t truly need it, you might want to ask yourself if this is a good teaching moment.
Remember, borrowing money can teach children many important life lessons and can also help them avoid common pitfalls. If your kiddo’s old enough to ask for an advance on their allowance, here’s how you can help them learn the basics of borrowing:
Talk About Budgeting
As with most financial lessons, teaching your child about borrowing money starts with a discussion on budgeting. Why? For starters, having a budget can help your child figure out if they can buy something with cash or if they need to borrow money. And if they need a loan from you, a budget can also help them determine how much they can afford to pay back every week.
When looking over the budget with your kid, remember to show them how much weekly allowance they’ll have left after making their loan payment. Some good questions to ask include:
- How much money do you usually spend every week?
- If you receive a $10 allowance and you pay back $5, how much will you have left?
- Does this cover your weekly expenses?
- Can you still set money aside for savings after making your loan payments?
Set a Payment Plan
Of course, lending your child $50 to get the coolest playset in the toy aisle is not a high-risk transaction. But it’s the perfect opportunity to teach them how a loan actually works. Before handing over your hard-earned money, take some time to make sure your child understands how much they’ll need to pay you back and how often.
To help your child visualize the commitment they’re making, take out the calendar so they can see the amount of time that it will take them to pay you back. This could be anywhere from a couple of weeks to a few months. When your child sees this, they may reconsider the loan altogether!
If they decide to go through with the loan, be sure to give them their full allowance amount and then have them pay you. It may seem redundant, but this is the best way for kids to gain awareness of the payment and how much money they have left.
Every time they pay you back, encourage your child to mark off their calendar as a way to keep track of how many payments are left. This is a great way to make goals part of the borrowing process.
Make Interest Part of the Equation
Charging your child interest for a $50 loan may seem harsh – but remember, borrowing money is an important life skill. That’s why many parents choose to charge interest, as a way to keep this exercise as realistic as possible.
If you charge interest, we suggest you keep it low and simple. This will help you get the point across without overwhelming your child. For example, if they borrow $50, you can tell them they’ll need to pay back $55 and break it up into 11 payments of $5.
How to Teach Your Kids the Different Types of Borrowing
As your kids grow older, their financial needs will evolve, and they may become interested in different types of loans. It’s important for them to understand the types of financing available and how these can be valuable resources if used wisely.
These are easy to understand because it’s basically what your child is requesting when they borrow money to get a new toy. If you choose to lend them the money, let them know that adults also take out personal loans for other reasons, which can include:
- Home repairs
- Moving costs
- Medical payments
- Emergency expenses
Many children are familiar with car loans just from watching commercials. Next time you’re watching your favorite family show and one of these ads plays on TV, use this as an opportunity to talk about car loans. Some good topics to discuss are:
- What is APR
- What is down payment
- How much is the average car loan installment
- What are some additional costs of auto loans and car ownership
With student loans as one of the biggest burdens for recent college graduates, it’s important to discuss them before your child starts their college application process. While these loans can help kids access a valuable education, it’s important to talk about:
- How much money to borrow
- Why it’s good to explore scholarships and grants
- Which career paths are most profitable
- Strategies to cover personal expenses while in college
Read our parent’s guide to student loans for more tips on understanding this type of borrowing and how to talk to your kids about it.
For many adults, credit cards are one of the trickiest financial tools out there. While many people get into massive debt by swiping their cards, others use them as credit-building instruments to help them access funds at low rates. The following conversation starters can help your child understand credit cards and how to use them to their advantage:
- The difference between credit and debit cards
- Why some credit cards charge more interest than others
- What happens if you miss a credit card payment
- How to use a credit card responsibly
How to Discuss the Good and Bad of Borrowing Money with Your Kids
Even as an adult, you hear a lot about good and bad debt, but it’s not always easy to determine which is which. When teaching your child about the good and bad of borrowing money, remember to highlight the importance of planning.
With a plan in place, debt can help you achieve your financial goals and enhance your lifestyle. But, even at a low interest rate, too much debt can become overwhelming and detrimental to your future.
When used wisely, loans can help you manage your finances and grow your wealth. The following are some of the pros of borrowing money:
- On-time payments help you build credit history
- Keeping a good credit score gives you access to cheaper loans
- Borrowing money allows you to buy high-ticket items such as homes or cars
- Loans let you keep cash for your everyday expenses and pay expensive purchases little by little
While loans can help in certain situations, they aren’t always the best choice. Understanding the negatives of borrowing money can help your child make smart decisions as an adult:
- Interest rate can make loans unaffordable
- The fees and penalties of missed payments can be high
- Applying for loans can hurt your credit score
- Too many monthly payments can make it difficult to afford your basic living expenses
How to Set a Good Example for Your Kids
Whether you have perfect credit or struggle with your own debt, talking to your kids about the realities of borrowing money is great for their financial education. The following are good ways to set an example for kids of all ages:
- Involve your child in your family budgeting process
- Talk to them about the monthly payments that you make
- Be honest about the financial mistakes you’ve made and what you wish you’d done differently
- Share your financial wins and what led you to make good decisions
Learning basic borrowing terms helps your child grow their financial vocabulary and do their own research on the topic. These are some of the words that you can help them understand:
- Debt: Money that you owe and that you need to pay back.
- Lender: The person or institution that lends the money, collects monthly payments, and charges interest on the loan.
- Borrower: The person or institution that borrows the money. Companies can also be borrowers, just like people.
- Interest: The amount of money that the borrower must pay on top of the amount borrowed.
- Credit: A loan that lets you purchase something without having to pay for it right away.
- Credit Score: The rating that you receive as a borrower, depending on how well you pay off your debts.
Books About Borrowing
Books are a great way to teach kids money lessons that don’t feel like a lecture. Here are some of our favorite books on borrowing money that kids will enjoy reading on their own or with you. Head to our money books for kids library for more great reads!
The Little Borrowing Brother
Perfect for younger kids, The Little Borrowing Brother is a relatable lesson on what it actually means to borrow money. Spoiler alert: Paying back is not always as easy as kids think it will be!
The Richest Man in Babylon
If you’re looking for a classic for your middle schooler to learn about good money habits, check out The Richest Man in Babylon. It’s filled with great lessons on living within your means, financial planning, and using money wisely to grow your personal wealth.
The Meaningful Money Handbook
For parents who want to tackle their own debt and teach their kids about financial freedom, The Meaningful Money Handbook is a practical guide to help you create the future you budget, manage, and make the most of your money.
Borrowing Money: An Essential Lifetime Skill
As you can see, it’s possible to teach children about borrowing money in an age-appropriate, useful way. Through honest conversations about how borrowed money works and practice at home, you can equip your children with the tools they need to make smart financial decisions. This helps set your kids up for future success as they learn how to navigate credit and use it to achieve their financial goals.