For Parents

How to Teach Your Kids About Loans

Loans is an important topic to teach to your kids so they can leverage them properly and build smart financial habits.

kids-with-parents-receiving-loan

Are your kids starting to ask questions about money? Although it seems like a grown-up topic, learning about personal finance is important at all ages. And if you’re wondering how to answer these questions, we’re here to help. 

One of the first steps that you can take to start your child’s financial education is to teach them the basics. This article will focus on loans and the best ways to break them down for your children. As your kids grow up and borrowing becomes a valuable tool, the knowledge you share on loans will help them make sound financial decisions. 

How to Explain Loans to Your Kids

When explaining how loans work to your kids, it’s important to highlight the positives and the serious risks that can come with borrowing money. The more kid-friendly information you give your child, the better prepared they will be in the future. 

Let’s start with some of the most common questions that kids have about loans and some good insight on how to answer them:

What Are Loans?

A simple definition is that a loan is when you borrow money from a person or financial institution with the promise to pay it back. 

Of course, there are many different types of loans and details that you can go into. But, in our experience, it’s best not to overwhelm kids at first. 

Later in this article, we offer a simple description of the types of borrowing out there, while also giving you the best tips and tricks for explaining how loans work to your children. 

How Do Loans Work?

Loans can be very straightforward: you borrow money and then pay it back later. You will most likely be charged interest when you take this money out. This is a percentage over the amount that you borrow. Interest rates can differ based on things like your credit score and financial history. But, basically, it means that once you have paid off the debt, you will have actually paid more than you initially borrowed. 

Why Would Someone Take Out a Loan?

Loans are super helpful when you want or need to buy something but don’t have the funds currently available. Loans are a useful tool that can be used when making both everyday and large purchases; these can include:

  • Buying a house 
  • Buying a car 
  • Paying for college education 
  • Covering unexpected expenses

What Are the Different Types of Loans?

Loans are very versatile, and nowadays, there’s a loan for almost anything. The diversity in loan types makes it easier to borrow money for your exact needs. The following are a few examples that can help you explain to your child how and why loans are used:

Personal Loans

A personal loan is money that you borrow from a lender that can be used for virtually any of your personal expenses. Some useful facts on personal loans include: 

  • They’re usually given out by banks 
  • The interest rate of the loan can be affected by your credit score and financial past – the better your financial history, the lower your interest will be
  • Personal loans are usually unsecured debt

Home Loans

This is a loan that’s used specifically to buy a house, condo, or other property. Here’s some additional information that you might find helpful: 

  • Home loans are secured loans 
  • With the actual property as collateral, it can be easier to get approved for a home loan
  • Interest is much lower for a home loan than that of a personal loan 

Auto Loans

As your child can probably guess, auto loans are funds you borrow to buy any type of new or used vehicle. This can include cars, motorcycles, or trucks. Some things to keep in mind when explaining these loans to your kids are:

  • Auto loans usually have higher interest rates
  • These types of loans are given by both banks and dealerships 
  • If paid off regularly, car financing can improve your credit  

Credit Card Loans

Although credit cards are their own independent concept, they are still a type of loan. Because credit cards are a must-have financial tool nowadays, your kids should know this important information to use credit card debt properly: 

  • Credit card interest can vary and change over time 
  • Not paying off a credit card can result in serious damage to your credit score 
  • Each bank has its own limits and rules when it comes to credit cards 

How to Explain the Pros and Cons of Loans

When teaching your children about loans, you should give them as much information as possible without overwhelming them. An objective approach includes sharing both the negatives and positives of borrowing money. Taking out loans comes with risks, and it’s important to encourage responsible money habits at a young age. 

Pros of LoansCons of Loans
– Allows you to make large purchases without having to pay out of pocket
– Can help you finance important investments, such as a college education or starting a business
– Borrowing and paying back on time can help you build a good credit history
– If loans are not paid off it, this can lead to bad credit score
– Some loans include high interest rates that can be difficult to keep up with
– Taking on more debt than you can afford can have serious consequences in your financial future

How to Set a Good Example to Help Your Kids Learn About Loans

Your example as a parent is the first thing your kids will learn about money. That’s why it’s so important that you model good money habits and have open conversations with your children about personal finance. Here are some of the easiest ways to set a good example for your kids:

  • Be open with your children about how and when you pay your loans 
  • Pay your credit cards on time 
  • Don’t take out unnecessary loans 
  • Avoid large purchases that you cannot afford
  • If it makes sense for your family or business, try to use borrowing as a tool to make more money    

Lending Your Kids Money

Should you give small loans to your kids to help them practice borrowing? Being in the position to give your children loans can help them develop good money habits. So next time your child wants to buy a new toy or hoodie, consider offering them a loan they must repay later. 

For many parents, these low-pressure situations are the perfect “training” for your kids to learn about loans. If you feel that lending your kids money is right for you, make sure you keep those loan amounts small. It also helps to set up a plan on how and when your child will pay you back. 

Important Loan Definitions

To help your kids fully understand what a loan entails, there are some key definitions that your child should know. Here is a list of our must-knows:

  • Principal: The money that you initially agreed to borrow and pay off. 
  • Interest: The extra cost of borrowing money from someone else. 
  • Lender: A person, institution, or group that lends money to others with the expectation that it will be paid back and receive interest payments.
  • Debt: The amount of money that a person owes someone else or to the bank.
  • Interest Rate: The percentage of the money that the lender charges the borrower.

Books and Other Resources to Teach Your Kids More About Loans

Looking for some extra resources to better educate your kids and yourself on loans? Look no further than our top picks to make teaching your kids about loans a piece of cake! 

What They Don’t Teach You in School About Money is an entry-level book that covers all the basics about money, loans, and investing. This is great for you to brush up on your personal finance knowledge and apply it to your everyday life. Remember, the more educated and well-versed you are as a parent, the better you will be at explaining finances to your kids. 

What is a Credit Card? Is the perfect storybook to use when you’re having trouble explaining credit cards to young kids. It follows the story of a little girl who watches her dad pay for food using a credit card. This real-life example is a relatable way for your kids to understand the use of credit cards. 

Looking for a hands-on way to teach your kids about finance? The Entrepreneur Game is a fun board game for the whole family! Learning about money doesn’t have to be a drag; it can actually be something your kids look forward to. Use this board game as a tool to teach your kids how loans can help them become entrepreneurs and financially intelligent. 

Let the Financial Learning Begin!

Now that you have all the tools and information needed to teach your kids about loans, it’s time to share your knowledge with your children. Start by answering their questions and get ready for some great conversations. You might be surprised at how fast kids can understand the concept of loans when explained in age-appropriate terms. 

Once your kids get this down, there will be no stopping them from becoming financially-savvy adults!

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About the Author

Lucia Caldera

Lucia Caldera is a writer who specializes in personal finance. Her goal is to create approachable content that sparks financial wellness and unlocks personal growth. Lucia's work reflects her passion for financial education as the key to reducing the wealth gap for future generations.

Last updated on: January 24, 2023