DebtDebt can be defined simply as ‘spending money we don’t have.’ The concept of ‘debt then payments’ is really the reverse of ‘saving then purchasing.’ Debt means getting something and then saving for it. The problem with doing this is that instead of putting your money in the bank to earn interest as you save, now you are being charged interest for borrowing it. Logically, it makes much better sense to wait until you’ve saved the money before you buy something! And the good news is that if this isn’t something that comes naturally, it can be learnt.
You will be offered credit when someone is prepared to trust you to buy now and pay later. So if you have a credit card, the credit card company will let you buy things immediately (without actually having paid anything for them), and then send you a bill later. It is possible to use credit to your benefit, without getting into debt. If you plan your spending, save for the things you want, and then shop properly using a credit card, you will be able to pay the bill when it arrives. This means you will be able to use credit without spending money you don’t have and having to pay interest charges.
Before they lend money, you will find that creditors want to know three things: Are you reliable? Is your income large enough to afford the payments? And is your income steady and secure enough for you to keep making your payments? Think about these three questions for a moment. Effectively, what you are being asked is this: ‘If you budgeted and saved, could you buy it yourself?’
Here are some practical suggestions you may find helpful. 1: Clearly, considerable self-discipline is needed to use a credit card sensibly. You may feel it is inappropriate to teach your children to have and use one. You may want to tell them to steer clear of such things. Only you will be the best judge of whether to introduce the concept and when. Many financial educationalists recommend a young adult getting a card and being taught how to use it. But it is essential that some ground rules are discussed and established beforehand. Write your agreed rules down – it will make it easier to enforce them if it becomes necessary. (a) The credit card is to be used for budgeted items only. (b) The credit card balance will be paid off in full every time a statement is received. (c) The credit card will be destroyed the first time the balance doesn’t get paid off in full and on time.
2: Help your child to understand the wider issues surrounding debt. Go beyond imposing rules to explaining the reasons behind the rules.
3: Borrowing commits you to a future obligation. Who knows what the future holds? You can’t guarantee being able to keep the obligation. On the other hand, saving implies acting on what you think and what you intend to do, and allows room for changes in the future.
4: Want a practical reason to avoid borrowing? How about this? If you invest £500 in a bond at 5% interest at the end of the year you would have £525 invested. If you owed £500 to a store card company over a period of a year you could owe around £650. Interest on what you owe is always higher (and sadly can be much higher) than on what you earn. If this is allowed to accumulate (this is called compound interest) the gap just keeps getting wider. So if you get a windfall seek advice, but it is almost always sensible to pay off your debts before investing.
5: It really is vital to teach your children to plan ahead, to save, and to spend wisely within their budget and means. If this becomes a habit in childhood, it will be much easier for them to resist the temptations that bombard all of us as adults. Teach them to build their finances a little at a time – they will be encouraged by seeing steady growth. It may sound harsh, but don’t act as a guarantor for their borrowing – and make sure they grow up understanding this won’t be an option for them. (Of course this doesn’t mean that you wouldn’t find another way to assist if they found themselves facing problems.)
6: If your children understand and follow budgeting principles, it is likely they will have their friends asking them for loans. It is OK for them to say “No”! Help them to realise this – it is just as important for their friends to learn that there are consequences for bad decisions.
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