If you care about your financial well-being, you’ve likely already begun to teach your children the basics of personal finance.
You may have taught them the value of a dollar by paying them to mow the lawn. Or, maybe you’ve shown them the power of compound interest by helping them deposit their allowance into a savings account. These are important lessons—instilling financial literacy at an early age helps set your child up for financial success.
Despite these lessons, however, there might be one thing that you’ve left off the table: credit.
All too often, parents fail to teach their children the ins and outs of credit. This can leave children with harmful misconceptions (“It’s free money!”) and bad habits (late or missed payments down the road).
It’s important that you help your child understand that credit is a valuable tool when used responsibly. By teaching them the basics of credit cards, credit reports, and loans, you’ll give them the knowledge and confidence they need to build up healthy credit for years to come.
It’s easy to understand why many kids grow up thinking credit cards are magical pieces of plastic that give unlimited access to free money.
When children see you pay for things with cash, they understand that an equal exchange is taking place: that meal (or pair of shoes, or new TV) is worth the amount of money you’ve handed over.
When you use a credit card, however, the visible “money” aspect is removed from the equation. By simply swiping a piece of plastic through the reader, you get to take home a brand-new item. No money involved at all!
As adults, we know it doesn’t really work like that. But without an explanation of how Mom or Dad could pay for something with that plastic card, it’s understandable that a child wouldn’t make the connection between a credit card and a dollar bill.
Once your child has shown interest in that “magical” plastic card (or even before then—if you want to be proactive!), explain to them that by using a credit card, you’re borrowing money from your bank. While you’re not paying with your money at that moment, you know that you’ll be paying the bank back for the full cost of the purchase in the near future (as long as you’re using your credit card responsibly).
Reinforce the idea that the bank has agreed to lend you a certain amount of money over and over again (that’s the magic of revolving credit!), as long as you pay them back what you’ve borrowed after each purchase or at the end of each month. If you don’t pay back all the money you’ve spent, you have to pay interest—and the longer you wait, the more interest you’ll owe.
It’s also important that you explain the difference between debit cards and credit cards. Because they’re nearly identical, your child may have grown up thinking you used your credit card for every purchase. Explaining to them that a debit card is different (you’re using money right from your own account, rather than borrowing it to cover each purchase) is a key differentiator.
“Finance speak” can be confusing—especially for young children. The best way to ensure that your child remains open to learning about money and credit is to explain things in a way they can understand.
One of the best comparisons you can use is likening credit to schoolwork. Your credit score is like your credit “grade:” It’s a marker of your performance that goes down every time you miss an “assignment” (payment). Your credit report is like a report card: it takes into account all the factors that contribute to your score.
If your child is a little older (or even a teenager), you may not need to simplify things as much. However, reading through credit card contracts (especially the “fine print”) can be intimidating for a first-time credit user.
Sit down with your teenager and walk them through unfamiliar terms and emphasize the importance of actually reading the entire contract before signing. Getting them into the habit of understanding what they’re agreeing to can help them avoid predatory contracts or unexpected charges in the future.
Has your child been eyeing that new game console, toy, or gadget? Chances are that her weekly allowance won’t cover the cost (unless she’s a pro at saving).
This is a great opportunity to show her how loans work. If you think she’s ready to take on the responsibility, loan your child the money to pay for the new item on the condition that she agrees to pay you back in full by a certain date.
It’s up to you whether you want to take this opportunity to teach her about interest, as well. You may decide that it would be a valuable lesson to impose a small interest rate after the agreed-upon date has passed. Even if you decide to forego the interest, it’s a good idea to draft up a simple contract outlining the terms and conditions of the loan.
It’s also important to emphasize the difference between wants and needs. While it’s possible to use loans and credit cards to pay for things she can’t immediately afford, it’s a better idea to come up with a budget and use her debit card or cash for everyday purchases.
It’s been said that children are like sponges—they pick up what they see and internalize it.
That means the behaviors you exhibit around money and credit will influence your children’s behaviors. While it’s important to teach your children about their finances, you’ll need to reinforce these lessons with your own responsible habits.
This doesn’t mean you need to be a millionaire or a financial expert—few people are! But building your knowledge base and adding some skills to your financial toolkit can help set you—and your child—up for success.
If you find that you’re reaching for your credit card to make expensive purchases or struggling to make consistent, timely payments, you may need to take a step back and reevaluate your relationship with credit.
Teaching your child about credit is a great place to start—reviewing the basics on how to be a responsible credit user can give you the refresher course you need.
If you need more of an in-depth review, Personify Financial has a wealth of resources that can help get you started. Check out our blog to learn more about everything from getting out of debt to 6 surprising things you need to know about credit.