How to teach your child about credit

How to teach your child about credit

If there's one area of finance your kids are unlikely to know about yet, it's credit. From understanding what it is, to how it works, learning about credit is key to helping your kids learn to make healthy financial decisions.

 

You may feel it's a while before your kids need to understand the world of credit, but as with all things financial, the sooner you start talking about it (in an age-appropriate way), the easier it will be. As with anything new, start with the basics and build up to the more complicated aspects – and be sure to reference your explanations with real-world examples.

 

What is credit and interest?

 

Credit is when you borrow money from a lender (person or company) on the understanding that you'll pay it back later.

 

Interest is the money the lender will charge you for borrowing credit. This is also known as the cost of borrowing.

 

Explain that credit is not free money

 

One important element to talk about is how credit is not free money.

 

Not only does it have to be paid back, but often you will pay back more than you borrow (this is known as interest).

 

Ask your kids to think of it this way: "Have you ever wanted to buy something for £15 but didn't have enough money? Maybe a video game or Robux, but you only have £5 so you need £10.”

 

When this happens, you have three choices:

 

  • Do without the item you want
  • Save until you have £15
  • Ask your mum or dad to lend you £10 and say you will pay them back (this is credit).

 

If your parents say yes, they may also say they will charge you an extra £1 for borrowing the money, this is known as interest.

 

This means the total you will pay back is £11 (£10 you borrowed + £1 in interest for borrowing it).

 

How do you pay the credit back?

 

When you buy something on credit, you pay it back at a later date that is agreed when you first borrow the money.

 

If you borrow from a parent, this might be in a week, or when you have your pocket money.

 

As an adult, if you borrow via a bank loan or credit card, you can either:

 

  • Pay it back slowly each month until the whole sum is paid off. Each month, you will see a credit balance showing how much you still owe, plus interest.
  • Pay it off in one go (this costs less as you've paid it back quickly).

 

Talk about credit card limits

 

Credit cards give you a line of credit with what’s known as a credit limit (the highest amount you can borrow, for example, £500). This limit can change at any time and lenders can keep increasing or reducing it. As long as you continue to pay back the agreed minimum payment each month and your balance (how much you owe) doesn’t reach your credit card limit, you can keep using the card.

 

However, with credit cards you also need to look for all the extra fees, such as the annual fee charged for having the card, and late payment fees when you forget to pay, as well as the interest rate on the money you borrow, which varies from lender to lender.

 

The big problem with credit is that it can quickly get you into debt (debt is the amount of money owed to lenders). Your debt will keep rising when:

 

  • You borrow more money than you can pay back.
  • You spend more money than you earn.
  • A change in circumstances means you cannot pay back the money you owe.

 

Is credit a good or bad thing?

 

There is no good or bad to credit. This is because credit is a part of our financial lives. Credit helps adults buy bigger things, for example, a mortgage for a house, a car, or a student loan so you can go to university.

 

This is why it's vital to know how credit works and how to build a good credit score (see below) as you get older, to ensure you qualify for loans when needed.

 

What is a credit score

 

A credit score is a number that represents whether you are a person who can be trusted to borrow money or not. Credit scores are based on personal financial data that shows how responsible you are with money.

 

When you apply for your first bank account and credit card, a credit report will track every time you make late payments late, become overdrawn (when you take more money out than you have), or apply for new credit cards or loans. The more responsible you are with your money, the more likely you will be deemed suitable to borrow when needed.

 

What's the difference between prepaid debit cards and credit cards?

 

A prepaid debit card like GoHenry might look like a credit card, but it doesn't function as one. Parents and relatives can put money into this account via pocket money, earnings and gifts to allow kids to make smart decisions around spending and saving. A prepaid debit card will stop working when the money runs out.

 

With a credit card, there is no money prepaid onto it, only a borrowing limit (see above). You are then allowed to spend up to this credit limit as long as you pay something back a minimum amount each month, and for this you are charged a fee (interest).

 

Get your kids added to your credit card as an authorised user

 

Although your teen can’t get a credit card until 18, you can add them to a credit card as an authorised user. This may seem a step too far, so it’s only something to try if you feel your child is ready. However, with the right conversations and guidelines, adding your teen to your credit card account can help give them a deeper understanding of finances and debt.

 

Parental guidance with credit cards will also help teens to start to create a good credit score and avoid bad credit habits for the future.

 

Bear in mind certain providers have a minimum age requirement from 13 to 16 years, so check with your provider. If they can’t become an authorised user, there are alternative ways for kids to learn about credit and get used to spending, such as a prepaid debit card like GoHenry.

 

Get your kids their own prepaid debit card

 

A prepaid debit card like GoHenry can teach your child valuable lessons about money that will stand them in good stead when they eventually apply for credit. Lessons such as saving and spending, paying attention to balances, and budgeting.

 

The best way to build good habits is by paying pocket money onto your child’s GoHenry card. The app then lets you choose how much your child is allowed to spend in a single transaction over the course of a week and at an ATM (up to a maximum withdrawal limit of £120 per day). This is useful when your child is taking their first steps towards independence, and you want to ensure they learn how to spend wisely.

 

Your child will also have access to Money Missions on the GoHenry app. These fun games and interactive quizzes are designed to build financial literacy, confidence and curiosity around spending, saving, earning, credit and all the financial skills your child will need throughout their lives.

 

 

Related articles

 

How to teach your child about budgeting

 

Activities to teach your child financial literacy 

 

Money management activities for teens

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Written by Anita Naik Published Aug 7, 2022 ● 4 mind. read