Assuming that children don’t need to know about finances until they are actually earning money is a big mistake. Finances are such a big part of everyday life and good financial habits will benefit your children for the rest of their lives. An essential aspect of this is the importance of credit and how it can work for or against them.
“Most people will need credit at some stage in their lives and it is important for parents to teach their kids to understand the basics behind how credit works to equip them with good money making decisions,” says Chris Labuschagne, CEO of FNB Credit Card.
Credit is a tricky concept, especially when it comes to compound interest. But this shouldn’t be a deterrent as there are ways of demonstrating the power of credit and interest through practical examples.
Demonstrating what credit is
“The very first port of call is to explain what credit is,” says Labuschagne. “The easiest way to start the conversation is to show them a credit card, as this is the most visible form of credit, and they have probably seen you take it out your wallet.”
Explain to them that the money in this card doesn’t actually belong to you, but it is a loan. You borrow it from the bank.
“To make credit more real, walk around your house and make your children guess which items where bought on credit,” says Labuschagne. “At the same time you can explain which ones you still owe money on, or those that you paid off. Make them understand that credit is very important because without it you wouldn’t be living in your house and driving your car every day.”
The next step is to teach them the difference between good credit, which is credit to build your wealth and bad credit.
“Demonstrate that good credit is funding assets that improve your life, such as your home or studies to get work, while bad credit is funding luxuries or cool stuff because you can’t afford them,” says Labuschagne.
“The main concept to explain and make your kids understand is that of interest,” says Labuschagne. “It is quite complicated, so you will need to break it down simply but, basically, show that they will be paying more for something that isn’t always necessary.”
Make real life examples to teach your kids. Find an item that they really want, such as a new phone and research how much it costs. If it costs for example R2000, with a pen and paper add up the months it would take them to save for this item out of their pocket money.
If they don’t earn pocket money, and you would usually buy items for them, for this exercise allocate a set amount of money for them each month, say R200.
Then explain that you will lend them the money. Very broadly add on 20% to the item and ask if they would be willing to pay R2400 for the exact same phone. Work out how many more months it will take them to pay for it.
“You don’t need to go into detail of how interest works, just show simply that they will be paying more for the same item,” says Labuschagne.
This would be a good time to show how interest can work in their favour as well. If they put their money into a savings account, they will have not only R2000 to pay for their phone, but also a bit more to spend on something else that they like.
The importance of budgeting
“Budgeting is a big part of all finances and now is the perfect time to show why a budget is so important,” says Labuschagne.
If they get a set amount of pocket money they need to know that they won’t get any more money, even if they are paying off their phone.
“Ask them how much money they need for say, airtime, a month and what about other things they use their pocket money for. It will soon become apparent that spending all their money on the new item isn’t not going to get them very far if they can’t afford money for other items,” says Labuschagne.
“Part of teaching your kid about being financially smart, is to teach them about their responsibilities when it comes to repayments,” says Labuschagne.
Again you can explain fairly simply with an example. If they have borrowed money from you to pay for the phone and don’t pay it back, it doesn’t mean that they stop owing you money.
Explain that it is the same when you borrow money from a bank to pay for items, you need to pay it back responsibly and that is why it is always important to not borrow more then you can afford.
“The most important tool in managing credit is learning discipline and being able to delay gratification. Parents are also responsible for setting a good example as this is an important part of learning,” concludes Labuschagne.