I remember the day I bought my first bike. It was a gold Raleigh Twenty. It was second hand, but I didn’t care. I’d saved the money for it. I’d found it in the classifieds section of the newspaper. And I’d bought it.
Back then, that’s just what you did. That’s what everybody did.
Teaching kids to save is still important. But in today’s get-it-now world of easy finance options, teaching them about borrowing money is equally important.
In our house we’ve used pocket money as a way of teaching how to spend, save and share money. But borrowing money requires a whole new level of understanding.
Why lend your kids money
Allowing kids to make poor financial decisions when they are young and the consequences aren’t life altering might help them avoid making similar mistakes later in life when the stakes are much, much higher.
Miss 10 had her heart set on a Lego Friends set that was no longer for sale in the shops. She found a set up for auction on Trade Me (the NZ equivalent of eBay) but time was of the essence – which is why she pitched her case for borrowing the money to buy it.
The next day, a second set appeared on TradeMe. This one wasn’t an auction – it had a ‘Buy Now’ price tag well above where the other set was sitting at auction.
After a crash course on how auctions work Miss 10 decided she had two options:
- Stick with the auction and run the risk of ending up without either set, or
- pay a higher price for the ‘Buy Now’ set, and run the risk of also winning the other auction, leaving her to pay off a much larger loan.
I left the decision to her. After all, borrowing $200 to buy lego and learning that it means you don’t have money to buy ice creams for the next few months at age 10 is better than borrowing $20,000 to buy a car and then not being able to pay your rent as an adult.
How to lend your kids money.
When teaching kids about borrowing money it’s important to make the situation as ‘real world’ as possible:
- Get them to pay a deposit: If they really, really want whatever it is right now, saving for or paying a deposit is a good way of showing it.
- Put a payment plan in place. Work out how much of their pocket money they’ll use to repay the loan each week, and discuss what happens with any extra money they earn or are given.
- Set a final payment date: base this on their weekly repayments and charge them interest on the outstanding amount if the loan isn’t paid off in time.
Miss 10 bought the ‘Buy Now’ Lego set. Then she won the auction. She was now the proud owner of more lego than she needed and more debt than she wanted.
Hire purchase or Lay by?
If they borrow money to buy something, do they get it straight away (as you would if you put something on hire purchase) or should you make them wait until they’ve paid the loan off in full (more like a Lay By)?
There is no right or wrong answer, but we decided to make Miss 10 repay the loan before she got the goods. I didn’t want her to think borrowing money was an easy option.
Miss 10 is nothing if not resourceful. Within minutes she’d convinced Miss 8 that she should also contribute by handing over some of her savings as a deposit, and also making a weekly contribution out of her pocket money.
Within 24 hours she’d convinced her friends to contribute towards the second set of Lego Friends to give as a gift for Miss H, whose birthday wasn’t too far away.
And she’d negotiated her way into a paid role doing admin for my business. While she wasn’t 100% happy with the pay rate or having to work to the specific deadlines I set, she did understand that it was the best way out of the situation she’d got herself into.
Within 48 hours she’d paid off the first set, and had a plan in place to get the debt completely cleared.
When to lend your kids money
I was amazed. And proud. Not just of her and her problem solving skills, but also of myself. Years ago I’d been advised to use pocket money as a way of teaching my kids to manage their money (as opposed to a way of getting them to do their chores) and I have to say that advice has paid off.
If you are going to lend money to your children it’s important they already understand how to manage money, and have proven they can save for something they want. For ideas on how to establish good money management skills, read my Parents Guide to Pocket Money.
There is no right or wrong way to lend money to children. How you do it – and whether you lend them any money at all – is entirely up to you. Just remember that you’re the ‘bank’ so you make the rules.