Money Truth #7

‘If money talks, Credit has an Echo!’ Bob Thaves

We are all born with nothing, but we have an immediate need for food, clothing and
shelter. If we are fortunate, our parents provide these needs for us until we are old
enough to work and support ourselves.

We then leave our parent’s care and must provide for our own needs. Since we have
not had the opportunity or ability to generate a lot of income up until that point in
time, it’s highly unlikely that we can totally avoid borrowing money.

We all know that money does not come without a price. If you earn it, it costs you
mental and physical effort. If you borrow it, it costs you ‘interest’ that grows
relentlessly. If you are not careful, interest can consume you like a hungry pack of
hyenas.

Given that it’s almost 100% certain that your kids are going to borrow money, you
need to teach them that debt must be kept at a safe level, planned, managed,
controlled and most importantly; paid off.

In ancient times, if you borrowed money and could not repay it, you became a slave
to the person you owed money to until you had worked off your debt or until 7 years
had passed.

In modern times you can easily become a slave to debt, but not in the same way as in
ancient times. Now you could work 2, 3, 4 (or more) days a week just to earn enough
money to meet loan repayments. If you do not keep up with your commitments it
will lead to legal action being taken against you.

If you borrow directly from less reputable people and cannot meet repayments, it
can even lead to physical harm. That can push people into crime and all manner of
outcomes, maybe even worse than slavery!

Your kids need to know about this!

As a parent, you should teach your kids the difference between wise borrowing and unwise borrowing. You should also teach them about the different ways they can borrow money, and the risks and costs associated with each.

When this information is considered with that of the last topic, consumerism, the reasons why your kids should avoid borrowing to purchase liabilities should be pretty obvious. If you do not teach your kids that the pain of repaying consumer debt is likely to be heaps more intense than the pleasure they get from making the purchase that caused the debt, they will find out the hard way.

Credit Cards

You should teach your kids that the only safe way to use a Credit Card is to pay it in full every month. An even better strategy to teach them is to not use one at all, however there are some payments you just cannot make using any other method.

The best strategy to teach them in that case is to immediately pay the amount paid by Credit Card off the Credit Card.

Here is a scenario.

Your child signs up for a phone plan. The phone company requires payment each month via Credit Card. Let’s say the amount is $50 a month and it’s due on the 10th of each month.

All your child has to do is set up an automated monthly transfer of $50 on the 10th of every month from their Savings Account to their Credit Card account.

If they do this for every recurring payment that has to be paid via Credit Card, they will never have to worry about Credit Card statements and due dates, because the amount owing will always be zero.

If they want to use a Credit Card to earn ‘points’, then they can use the same process. If they have the available funds to pay for an item, but wish to use the Credit Card, transfer the funds immediately before using the card to make the purchase.

Make sure they understand though, that human nature is a very strong force and it takes nerves of steel to actually do what I have described above. It is so easy to convince yourself that you will ‘do it later’ and the funds transfer never happens! Doing it before the transaction is the only way to short circuit human nature in this situation, otherwise Credit Card debt can easily sneak in.

Earlier we saw how using borrowed money increases the cost of goods purchased.

You need to teach your kids that ANY borrowed money they take on puts them at risk. You need to also point out the additional risks presented by Credit Cards.

Risks of Borrowing

1. It is easy to overlook the pain of making repayments when you’re looking at the
‘thing’ you want so badly that you can’t wait to save up for it and you must have it
now. There is a huge risk that ‘desire’ can cloud common sense before using credit to
make a purchase.
 
Teach your kids that in almost all cases, the pain of the debt is far more intense than
the pleasure of the purchase!

2. Life circumstances can change, sometimes very quickly. If your kids feel they can
afford the repayments when they decide to use Credit to make a purchase, they
need to keep in mind that things change. They could lose their job unexpectedly, a
pandemic could break out, a war, drought, flood or earthquake could increase their
cost of living.

Teach your kids to leave room for change when they are borrowing money and
considering what repayments they can afford. They should endeavour to pay off
debt as quickly as possible while they have the capacity to do so, so change is less
likely to cause them grief.

3. When you regret borrowing, it is often the case that selling the item you borrowed
the money for, will not clear the debt. There is a high risk of becoming stuck between
a rock and a hard place when you borrow for consumer items/liabilities.

Teach your kids that the pain of regret is far worse than the pain of saying NO to
yourself.

Additional Risks Associated with Credit Cards

If I handed your kids $1,000 each and said, “spend it any way you like” that would
most likely cause quite a bit of excitement, and I imagine it would get spent pretty
quickly.

If I handed your kids $1,000 each and said, “you can use it any way you like, but
every month you MUST show me that you still have my $1,000”, that might be
helpful to your kids, but it would not be anywhere near as exciting as me just giving
them $1,000 to spend.

If I modified the second offer so your kids got the $1,000 and I said, “you can use it
any way you like, but every month even though it would be great if you could show
me that you still have my $1,000, if you can only show me that you still have $25,
that will be OK, but you will need to pay me 20% interest on the $975 that you spent
in that case, then it is very likely some (or all) of your kids might find it just too hard
to resist the temptation to go shopping with my money, and end up paying me some
(or lots), of interest. 

1. Credit Cards have a huge risk in that the Monthly Statement shows how much you
spent and should pay back to avoid paying interest, but they offer a ridiculously small
minimum payment option to entice you into spending money that is not yours. If you
only pay this amount, you will incur high interest charges.

You should warn your kids NOT to go down the ‘minimum payment’ path!

If your kids only pay the minimum payment amount every month it could easily take
them 30 years to pay off Credit Card debt (including a huge amount of interest).

2. Another huge risk with Credit Cards (that a lot of people are unaware of), is the
risk presented by the psychological difference between paying with cold hard cash
and paying with the bank’s magic plastic. It has been repeatedly demonstrated by
studies that people are much more likely to make a purchase using a card than using
cash. If they must use cash, people will usually think a lot harder and longer about
the purchase and are more likely to walk away.

Make sure you let your kids know about this. Teach them to use cash and to only
spend money that they have!

The Buck Stops with Them

Bright shiny objects and easy finance will be very attractive to your kids when they
are young adults unless you make a point of warning them about the consequences
of being lured into debt by such things. You need to explain to your kids that just
because the bank or a finance company says they qualify for a loan, it does not
mean they can afford to repay it! It’s always their responsibility to ensure
they’re able to meet repayments – it’s not a decision that someone else makes for
them!

Credit Scores

Recent changes to consumer credit law means that everyone who has applied for
credit or a loan has a Credit File and a Credit Rating (or Score) that is determined
by how well they meet their financial commitments and behave responsibly with
money. A low score means you will have less ability to borrow money and when you
do, it will be at higher interest rates, and a high score means you will find it easier to
borrow money and at lower interest rates. 

Many adults have yet to understand the implications of these changes, let alone
looked up their score, or taught their kids about it!

You have the right to get a copy of your Credit Report for free every 3 months. It’s
worth getting a copy at least once a year. Your Credit Report also includes a Credit
Score. This is the ‘band’ your Credit Score sits in (for example, low, fair, good, very
good, excellent).

Usually, you can access your report online within a day or two. Or you could have to
wait up to 10 days to get your report by email or mail.

There are also others offering free instant Credit Score services. You need to give
them your contact details so be aware that you may also start receiving offers of
other financial services from them as well.

If your kids miss payments, overdraw Credit Cards, cause negative bank account
balances by having automated payments falling due when there is not enough
money in their account to pay them, or any other negative financial activity, they will
have a low Credit Score.

The outcome of having a low score is that when your kids want to borrow money for
a house or a car (or anything else), they may be declined the loan, or be charged a
higher interest rate than they would have if their Credit Score was higher.

You should educate your kids about Credit Scores and the importance of building up
a good one! 


By the time they reach adulthood your kids should know…

• The benefits of saving up to purchase the things they want
• The cost of borrowed money 
• The different institutions they could borrow from 
• The different credit products available 
• The difference between secured and unsecured credit 
• How repayments and interest work together as they pay off a loan 
• The reasons for the different fees and interest rates associated with different loans/credit facilities and the risks and dangers of each 
• The difference between a Credit Card and a Debit Card 
• How a Credit Card works, i.e. what happens between making a purchase and making a payment? 
• How to read a Credit Card statement 
• When interest is charged on a Credit Card and why. 
• How interest is calculated and charged with a Credit Card • How to look up their Credit Score 
• What information determines their Credit Score 
• How their Credit Score impacts their life 
• That just because they are offered finance it does not mean they can afford it or that it is in their best interest to accept it. 
• How debt can cause stress, feelings of hopelessness and in extreme cases, can even lead to physical harm and crime.