It’s a fact of life, that at some stage your children will need a loan in their lives for a car, home or a luxury item. It is therefore important as parents, that we not only teach our children about saving money, but also what is involved in obtaining a loan, interest rates, repayments and defaults.
Pay Them for Chores…
As soon as children are old enough to understand money, they should receive pocket money in return for simple chores around the house. It might commence with tidying their room and putting their toys away, with the responsibility and amount increasing with each year. The general rule is $1.00 per year old they are (eg. at 5 years old they receive $5.00, at 10 years old they receive $10.00). Right from the start you should encourage them to put a certain amount into savings vs spending (again, the general rule is 50% saving, 50% spending) and you should decide whether they can spend any of their savings. Keep in mind, if you follow these two rules, a child receiving pocket money from 3 years old until they are 17, will save $3,900 by the time they are 18 – and that’s, not taking into account interest or additional top ups from birthday gifts or a part time job.
But I Want It Now…
Every parent has had their child want a certain toy or item NOW. Here you have several options:
- Buy it for them. (Sure, your child will be happy, but this article is about teaching them about money, so maybe not the best option).
- Encourage them to save the entire amount for the purchase.
- Tell them that if they save half, you will pay the other half of the purchase price.
- Offer them a loan.
Now might be the perfect time to teach your children about loans, in a safe and practical manner. It will make them really think about if they want that toy now – remember to point out that it will cost more in the long run – or if they can save for it themselves. To make it a real-life lesson, remember to:
- Ask your child to complete an application form. They should include their name, the reason for the loan, why they need that item and the purchase amount.
- Include interest on the loan. If your child is too young to understand percentage, add a cent amount per week of the loan.
- Include what will happen if they don’t repay the loan. Will you take the toy from them or suspend all pocket money until paid in full?
- Include a term of the loan.
- Work out how they are going to pay back the loan. Are they going to do extra chores around the house or change their pocket money habits by maybe saving 50%, spending 25% and loan repayment of 25%?
- Set a day each week on which the loan repayment should be made.
- Sign the paperwork and make sure they understand the terms of the agreement.
- Print up the repayment schedule and put it up where your child can easily see it.
- Enforce the repayments. If you don’t ensure they make the repayments, they won’t learn that a bank won’t be as forgiving!
- Each week, give them their pocket money as usual and have them make the payment to you on the set day. Write the amount on the repayment schedule so they can see the amount reducing clearly.
- If old enough, encourage them to do the maths themselves!
- When the loan is fully repaid, either write in red texta “paid in full” on the agreement or have them tear up the agreement.
- Praise them each week when they make their repayment. And reward them with a hug when they have repaid in full!
It’s getting serious now…
Soon will come the time that your child has grown and will be wanting to buy their first car or house. Unless they have been meticulous savers, usually parents will be required to give assistance. Usually, the first thing you will need is a deposit.
When purchasing a car, depending on where you intend to make the purchase, a deposit of approximately $500 will be required. When buying a house, the deposit is a lot more daunting with a 20% deposit required to ensure you don’t have to pay crippling mortgage insurance. There a number of things you can do though to help them sort out their property deposit:
- Providing a cash gift or loan
- Saving for them from childhood
- Acting as a guarantor
- Joint venture
- New mortgage products
- Cash Gift, Loan or Saving from Childhood – It certainly is generous to be able to either lend or gift the funds needed to your child, but not everyone has the money available and then they will need to be making repayments to you on top of their mortgage. Also, some borrowers who do not have a strong credit history, may also need to show a savings history to prove they can repay the mortgage to the lender. If your child is young as you read this, you may want to open a term deposit for them and encourage them to add to it from their pocket money and other income. Another consideration is to charge them rent if they live at home whilst continuing further study or working full time, and putting that rent into a term deposit for a home loan when they are ready. Not only will this teach them healthy money habits, it will also help them get on the property ladder!
- Guarantor Loans – Another option is to act as a guarantor for your child on their loan. Your home is put up as collateral and acts as a form of security on the mortgage for the lender. You will need to either own your property outright or have a certain amount of equity in the property for this to be possible. There is risk though – if your child defaults on their mortgage, your home could be taken by the lender. So, go over the sums with your child to ensure they will be able to make the repayments so you don’t lose the roof over your head.
- Joint Ventures – This option enables you and your child to purchase a property together. This is a good option if your child cannot afford the property entirely on their own and you don’t wish to act as a guarantor. With a joint venture, you both own the house and have the responsibilities of the repayments and home ownership. You have the choice to split the mortgage 50/50 or you could allocate a different percentage depending on the finances available. Once the mortgage has been repaid or if your child’s financial situation changes, you have the option for them to buy you out, you sell the property and split the profits or you keep the property as an investment and they use their share of the equity to purchase a new property of their own. Even if you are not living there, you will probably have an interest in the property and ensuring that it is well maintained. To avoid confusion and arguments, ensure you have a clear agreement as to how much each of you pay for the mortgage, rates, maintenance, insurance and other costs pertaining to the property itself.
- New Mortgage Products – Some lenders are now offering products which allow parents to assist their children to purchase a home with specials loans parents provide to their children through a lender. Discuss this option with your broker or mortgage provider.
At the end of the day, it’s most important to…
As always, there are some important key points to keep in mind:
- Always discuss the financial situation with your lender to see what options are available to you and your child
- Never agree to anything which you are uncomfortable with
- Always have any agreements you make with your children, written in a formal legal document
- Ensure your child understands any mortgage or loan documents they are signing and their responsibilities
And remember – discussing money and finances with your children throughout their lives will give them a greater understanding when adults themselves.