Teaching Kids about Borrowing Money

Teaching kids about borrowing money may not seem like an important factor for kids to learn but a small lesson on it can help kids plan for the future.

Sometimes the price of an item makes it impractical to buy without borrowing at least some of the purchase price. The decision to borrow  for such purchases should never be taken lightly and children need to be taught the difference between necessary and unnecessary borrowing. Because of the ease with which cash can be borrowed today, many find themselves living beyond their means and in bondage to their creditors.

Teach the Rules about Borrowing Money

Kids need to know that when a person borrows funds, that person actually pays more than the original cost of the item because they are also buying time. The cost of that time is added to the amount borrowed and is called interest. The best way to teach kids about borrowing money is to get them involved the next time you take out a loan for a big purchase such as a house or car.

Explain that, "We need a new car but don't have enough cash to buy it. We could save enough to buy a car but that would take many years and we need a car now to drive to work, the grocery store, etc.

Tell them, "the bank is going to lend us the funds so we can buy the car now, and we have to pay it back over the next few years. In addition to paying back the amount borrowed for the car, we also have to pay for the time they are giving us to pay them back. The value of the time to pay the bank back is called interest."

Let them see the value of time

Every time a bank lends cash to someone, they are required to give them a "Truth in lending statement". This statement shows the amount borrowed plus the "time" amount, or the amount that will be paid in interest.

Show them the total interest that has to be paid and tell them, "this is the extra amount we have to pay so we can buy our new car now." This is an important factor when teaching about borrowing money because most people don't realize the extra amount you are paying in the long run.

Necessary and Unnecessary Borrowing

The line between necessary and unnecessary borrowing can be a bit fuzzy at times, as is the line between wants and needs. A basic rule is that it's okay to borrow for immediate needs if and only if you have the ability to repay the amount as agreed. "Wants" should be saved for.

However, just about any "want" can be rationalized as a "need" in our mind if we work hard enough. It takes discipline to keep wants and needs separate, but those who do are more likely to live within their means, while those who don't are more likely to get into financial trouble.

Our basic needs today are shelter, food, transportation, medical care, and education; but even these can be divided into wants and need categories. For example, people need a house, but does a three person family with no plans for more kids need a six bedroom house with a three car garage and a two acre lot? Probably not! So keep that idea in mind when teaching kids about borrowing money.

Caution against Instant Gratification

Some people borrow when saving would be more appropriate to satisfy the need for instant gratification. While just about everyone has done this a one time or another, it's never a good idea as it can easily become habit forming.

Every household should have something they are saving for, even if they have the funds to purchase it now. Why? Because it teaches children, and us for that matter, to exercise discipline and delay instant gratification. Saving has almost become a lost principle in our day of easy, cheap credit.

Plan for the Unexpected

Most people who get into serious financial trouble do so because the unexpected happens. Some people live at or beyond their means because they expect their financial situation to improve through pay raises, promotions, etc. Then the unexpected happens and they end up unable to meet their obligations. So plan for the unexpected by living so that you can put some cash in savings each month as a guard against the unexpected. And if the unexpected never happens you will be even better off.




See details on our Teaching Kids about Money Ebook for more lessons on banking, checking accounts and credit cards as well as more money lesson plans designed to teach kids basic concepts and using cash in everyday life.