Children learn how to handle money by watching their parents, and thus they will inherit most of the same financial habits that their parents display. Therefore, the example that you lead will influence how your children handle their money for the rest of their lives.
It is important that you begin financial education early, ensuring that your children understand the pros and cons of spending, investing, saving and debt. Teaching your children about money should be a basic part of their education, ensuring good habits last throughout their lives.
Understanding your own financial behaviour is the first step to teaching your children about money. Identify traits that you would like to pass on and those which you would rather not. If your children grow up in a household where their parents are frequently stressing about bills or their mortgage, or often facing large credit card debts, they are more likely to pick up bad habits.
A key concept your children should understand is delayed gratification – the idea that we must wait to enjoy something. We have to work hard and save up before we can indulge in luxuries such as holidays abroad, or a new phone. Children should learn that they will often have to wait for their desires to be satisfied, and the process of earning and saving for a big purchase can make it all the more satisfying.
However, there are some things which we may choose to buy before we can afford to pay for them. The most obvious example is a house – we may choose to go into debt by taking out a mortgage to buy a house. Similarly, many people take out loans to go to university. There are situations where it is appropriate to borrow money – people need a home to live in, and houses are often an appreciating asset, likewise a university education can lead to higher earnings long-term, making it a worthwhile investment. It may be worth explaining to your children the difference between good and bad debts.
Taking out a loan that can benefit you financially, for example to purchase a house that may increase in value and is an incredibly useful asset, is a good debt. Going into debt to fund a flashy lifestyle, with expensive clothes, food and holidays can lead to serious financial difficulties.
Finally, it is important to explain that debt, whether good or bad, is a serious obligation. Defaulting on a loan can damage your credit score, cause legal troubles, and affect your mental health and personal relationships.
You may choose to loan some money to your children when they are young. Perhaps your 12-year-old wants to go to the cinema with some friends but does not have enough money, you could lend them the money and allow them to pay it back in the future, either when they have received some pocket money or earned their own cash, helping them to understand the concept of debt.
When discussing debt, the next important concept to understand is interest. Your children may have already received some small interest if they have had a bank account. They may not know, however, that borrowing money incurs interest payments for the borrower.
You may explain why lenders charge interest, and why some debt, such as credit cards, has a much higher interest rate than mortgages and financed cars, which are backed by collateral. You could show and explain to your children how a credit card works, in particular how this debt can improve your credit score if paid off in a timely fashion.
Saving is often the first step in a child’s financial education, and it is generally an easier concept to teach than debt. However, it is important to understand how savings matter when discussing debt. Saving allows for expensive purchases in the future, protects you against unexpected expenses and puts your money to work, earning you some passive income.
Having some money in the bank is therefore especially important when borrowing. Having a reserve of cash ensures that you can stay on top of interest and repayments, protecting you from serious hardship. When your child is old enough, you can introduce the concept of budgeting and how money flowing in must be split between essentials, managing debt and setting aside money for your savings. Any excess can be spent on leisure activities such as eating out or trips to the cinema.
By the time your children have reached teenage years, they will hopefully be able to begin to understand the complexities of adult financial life. Although they may not have significant income of their own, and they certainly will not have large debt obligations such as a mortgage, you can further their education by sharing more about your financial situation.
Discussing your mortgage, car loan and investments in detail with your children will offer them invaluable insight into how finances work as an adult. You can explain how you budget and manage your own finances and debt, helping to prepare them for their future. If your child chooses to go to university, you may well also need to discuss student loans, and how to manage this significant obligation.
The importance of financial education cannot be understated in your child’s upbringing, and debt is of particular importance. Although often seen as a frightening concept, it is important to educate your children on the different types of debt, how to manage it, and when and when not to take out loans. You as a parent can ensure your child makes educated and responsible decisions into their future.