by James Jones

Created on: September 22, 2008

How to teach your children about credit and debt

Let's first establish what you want to teach your children about credit and debt, that is: avoid it whenever possible. Keep the rules simple: "Debt is acceptable in the form of a mortgage for a house or a car loan" (strictly only the mortgage, but I include car loan as cars are as necessary as a house and are a major investment). The things we genuinely must have but may not be able to save for. Reinforce the message often and from an early age there are plenty of ads on TV and billboards that could initiate this. Make it clear how stupid it is to borrow money to go on a holiday or to buy a household appliance and how debt leads to debt.

Explain to your children how borrowing money leads to less income leading to more borrowing. Hammer in early and often that the only acceptable borrowings are for a house and a possibly a car.

If you have managed your finances well you can teach your children by example: by explaining that you are able to go on holiday because you saved for it, or that you could upgrade your computer because you've been putting money aside for it.

If, on the other hand, you haven't been able to manage your finances that well you can use that as a perfect example of what not to do: "We can't do a vacation this year because we have too many credit card payments to make".

I touched on the simple rules of credit at the top. Simple rules are good because you, and your children, will easily know when they are breaking them. Credit cards aren't so simple.

In a perfect world the golden rule of credit cards would be: "Avoid having them at all cost." Unfortunately they are necessary in many situations, such as checking into hotels or renting cars. If you must have a credit card make sure the credit limit is no more than you need (somewhere between US$ 1,000 and 2,000 should be more than enough) and back it up with cash savings that match the limit. That way you can always pay off your card, even if you have to use it in an emergency. So tell your children that they should have one credit card only, with a small limit backed up by savings.

The flip side of managing credit and debt is to have savings. The message for the kids should be: "Start early." Teach them from an early age about saving by letting them save pocket money to buy a toy they really want. Tell them from an early age about the importance of saving a fixed portion of their income from the first job onwards 5% to 10% of the after tax income should go straight to a savings account, more if possible.

To recap the golden rules of credit:
1) Only borrow to buy a house, a car is allowed if you have to.
2) Minimise credit cards by having only one card, with a low limit backed by savings.
3) Save, no matter how small your income is. The smaller your income the less you can afford NOT to save.

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