How to teach kids and teens about debt

Teaching your kids about money often involves developing a real-world understanding of spending and saving. But sometimes parents miss a big piece of the financial puzzle: debt.

The goal of many parents’ money and allowance programs is to teach children to avoid debt. If we teach kids to be fiscally responsible by only spending what they earn while regularly setting aside money for savings, they shouldn’t have to worry about debt, right?

But debt is a part of life, of course, even and maybe especially a fiscally responsible life. As children grow into teenagers, they should gain an understanding of debt, because they will soon encounter it in the form of student loans, car loans, credit card offers and mortgages. Adult life is riddled with debt — good and bad — and it’s important for kids to learn how to manage it.

Lead by example

One of the most important things you can do is show your children how you manage debt. This includes showing them how you pay bills and how you use credit cards. Starting at a young age, explain to them at the store how you are using your credit card. Then, when you’re at home, show them how you pay the card off.

Have your child sit down with you while you pay bills and show them the paperwork or online portal you use so they can see how it works. Make sure they see the connective thread between the thing you bought and the payment — you can even show them the line item for the purchase so they see your debt log.

Use a debit card as training wheels

You can’t get into debt with a debit card, but you can practice using plastic. If your kids are used to handling cash from allowance and odd jobs, a card is going to look and feel different. Get them used to checking their balance online, on their phones, or at an ATM before spending, and managing their cash with a checking account. Make sure that whatever checking account and debit card you introduce them to has the right benefits and security options for minors.

Then once your child has shown they can be responsible with a debit card, you can add him or her to your credit card as an authorized user to start actually building credit. Just make sure you fully explain your expectations for this card’s use (charging a small, regular amount that is easy to pay off within the month) and how they will repay any expenses incurred.

Offer practice debt

Childhood allowance and saving programs are often set up to encourage your child to save up for something he or she wants, like a bicycle, and they should be. Your kid needs to learn sweat equity. But as your children get older, you may want to introduce the concepts of debt and credit in a more tactile way because, let’s face it, 18-year-olds often need things like a college education or a car to get from A to B before they can pay for them in full.

In this scenario, however, let’s say your child wants a new video game system that costs $200, but with $100 in savings, he doesn’t have enough to purchase it. Offer to lend him the other $100 as a loan with interest and terms.

Make this transaction very official. Draw up paperwork that outlines the terms of the loan and have the both of you sign it. Include things like:

• The total amount of the loan and total amount your child will pay over the life of the loan with interest.
• Interest rate: Keep it simple and realistic. Don’t charge too little or too much or the lesson could get lost.
• Payment schedule: Minimum payment, and how long it will take your child to pay off the loan if he pays the minimum amount each month only.
• Payment due date: Set a date that payment is due, and the method in which you would like to be paid. Think about hanging an envelope on a bulletin board or the fridge where you expect your teen to independently deposit the cash by the due date. Or have them set up an automatic transfer through their checking out or a service like Venmo.
• Non-payment penalty: Spell out what happens if your child doesn’t pay one month. Will you remind him once if he is late or will you immediately assess a fee? Credit card companies often charge a flat and hefty fee of $25+ for a missed payment, so consider a similarly painful fee for non-payment.

These terms also give you a great opportunity to discuss credit scoring (and make the discussion of credit scoring part of the loan “approval” process!) and how it works in the real world. While you may not want to get that complex in your agreement, tell your child that if they miss payments, you will be reticent to lend to them in the future, so future loan terms will change. You may choose to lend smaller amounts, charge higher interest rates or not lend to them at all. Conversely, if they make all the payments in full and on time, you will likely trust to lend to them again and may offer better terms, such as a lower interest rate or higher loan amount. This is the basis of a credit score anyway!

Remember that any loan program you offer should not come at the expense of your child’s savings. They should have a savings account that they fund with their earnings and their debt repayment should come from their spending money, not their saving money. Ensure that their monthly debt payment is possible within the parameters of their monthly income, just as bank would, and don’t let them bite off more than they can chew.