Teaching your children about loans and credit will be one of the most important lessons that you need to teach your children. Loans and credit are the underlying foundation of financial services and as your children grow, they will encounter loans and credit. Learn how to teach your children about credit to ensure their financial knowledge is thorough in order to get them ready for money management when they are adults.
1. Explain what a loan is
Your children should understand from a young age what a loan is. A loan is essentially a promise from one person to a financial institution to pay money back on time. If you explain it like this, you will be able to teach your children the basic fundamentals about what a loan is and how it works. Whether it is a payday loan, a consumer loan or a mortgage, loans are about making a promise to return money back (with interest) on a specific date.
2. Explain what a consumer loan is
The growth of consumer loans in the UK has expanded choices for parents, families and as a result, children as well. Your older children should understand what a consumer loan is. It is a loan that is meant to be used for personal use (hence the name consumer). Consumer loans are going to be more important as Brits look for alternative credit sources as bank lending tightens. Banks are looking for people to deposit money, while consumers are looking for credit. This was highlighted by the Chief Economic Adviser of the British Bankers Association who said in a recent release that consumers are choosing short term lending for their spending.
Your children should understand that consumer loans are only for adults who have a job that pays them a salary every month. Your children should know that consumer loans are for responsible adults who are in work, and that it is something that they can choose in their future but not now.
3. Tell them what a mortgage is
Shelter is a right for all people especially children. If you own your own home, it is more than likely that you have a mortgage to pay for your house. Explain to your children that a mortgage is a promise to pay for a house but it is done under the assumption that if you don’t keep up your payments the bank could repossess the house. Mortgages can be explained to older teenage children in order to show them the value of money and the importance of having somewhere to live.
Mortgages will take on a special meaning for your children especially once they become adults. A study from Legal & General found that that more parents are giving their children loans to buy a deposit for a house, and in addition the majority of these loans are ‘free’ in that they bear no interest or they are given as gifts to children. This is why mortgages are so important for your children to understand because they might need to approach you for financial help to buy a house.
4. Explain to your teenagers how business loans work
Entrepreneurship is the new black and every country in the world is churning out successful entrepreneurs at any age. It is no longer about being older and taking a chance on business. More teenagers and young adults are going into business. If your teenage child wants to do a part-time business once he or she turns 18 for example, you need to explain to him or her how business loans work. Your children need to understand that borrowing money from you or going to a bank to borrow money to start a business are two different things. Banks are proper financial institutions that will want to see proof of success and possibly collateral. Your children need to understand that businesses cannot operate without credit but getting credit for a business from a bank is extremely difficult due to the cash crunch.
5. Tell them what interest is
You probably know the ins and outs of APR (annual percentage rate) which is how interest on a loan is worked on. One of the best ways to explain this to your older children is telling your children to imagine a cake without icing. A freshly baked cake from the oven needs icing. The bank will give you the cake with icing on top, and the icing is the interest in this example. You need to give back the icing and the plate that the bank gave you, and this is essentially how loans work. Your children need to understand that if the bank is offering you a ‘cake’ with ‘icing’, you need to give them everything you consumed and more icing. This will teach children what interest is and how it works.
6. Explain how repayments work
In addition to teaching your children what APR is and how it works, repayments are how borrowers get out of debt and build a strong credit rating profile. You need to teach your older children that they should always make repayments and ensure that they don’t fall behind on making repayments when they are adults and ready to do so.
7. Adult children need support with finances
Adult children who are under the age of 35 also need support when it comes to learning more about loans and credit. Due to the rise of parents lending children money and the low rate of savings amount this generation, you should give your adult children thorough lessons in how they can save more money and use loans and credit to their advantage.
Your children are the future generation of the country. As long as you think they are old enough to understand, you should teach them the basics of personal finances and explain the importance of credit and how it works. By knowing how it works, when they are ready to borrow money when they have a job, they will not be overwhelmed when it comes to managing their loans and credit.