Your first lesson isn’t actually one of the six.
It can be found in the title of this article. The best time to start teaching your children about financial decisions is when they’re children! Adults don’t typically take advice well from other adults (especially when they’re your parents and you’re trying to prove to them how smart and independent you are).
Heed this advice: Involve your kids in your family’s financial decisions and challenge them with game-like scenarios from as early as their grade school years.
Starting your kids’ education young can help give them a respect for money, remove financial mysteries, and establish deep-rooted beliefs about saving money, being cautious regarding risk, and avoiding debt.
Here are 6 critical financially-related lessons EVERY parent should foster in the minds of their kids:
1. Co-signing a loan
The Mistake: ‘I’m in a good financial position now. I want to be helpful. They said they’ll get me off the loan in 6 months or so.’
The Realities: If the person you’re co-signing for defaults on their payments, you’re required to make their payments, which can turn a good financial situation bad, fast. Also, lenders are not incentivized to remove co-signers – they’re motivated to lower risk (hence having a co-signer in the first place). This can make it hard to get your name off a loan, regardless of promises or good intentions. Keep in mind that if a family member or friend has a rough credit history – or no credit history – that requires them to have a co-signer, what might that tell you about the wisdom of being their co-signer? And finally, a co-signing situation that goes bad may ruin your credit reputation, and more tragically, may ruin your relationship.
The Lesson: ‘Never, ever, EVER, co-sign a loan.’
2. Taking on a mortgage payment that pushes the budget
The Mistake: ‘It’s our dream house. If we really budget tight and cut back here and there, we can afford it. The bank said we’re pre-approved…We’ll be sooo happy!’
The Realities: A house is one of the biggest purchases couples will ever make. Though emotion and excitement are impossible to remove from the decision, they should not be the driving forces. Just because you can afford the mortgage at the moment, doesn’t mean you’ll be able to in 5 or 10 years. Situations can change. What would happen if either partner lost their job for any length of time? Would you have to tap into savings? Also, many buyers dramatically underestimate the ongoing expenses tied to maintenance and additional services needed when owning a home. It’s a general rule of thumb that home owners will have to spend about 1% of the total cost of the home every year in upkeep. That means a $250,000 home would require an annual maintenance investment of $2,500 in the property. Will you resent the budgetary restrictions of the monthly mortgage payments once the novelty of your new house wears off?
The Lesson: ‘Never take on a mortgage payment that’s more than 25% of your income. Some say 30%, but 25% or less may be a safer financial position.’
3. Financing for a new car loan
The Mistake: ‘Used cars are unreliable. A new car will work great for a long time. I need a car to get to work and the bank was willing to work with me to lower the payments. After test driving it, I just have to have it.’
The Realities: First of all, no one ‘has to have’ a new car they need to finance. You’ve probably heard the expression, ‘a new car starts losing its value the moment you drive it off the lot.’ Well, it’s true. According to CARFAX, a car loses 10% of its value the moment you drive away from the dealership and another 10% by the end of the first year. That’s 20% of value lost in 12 months. After 5 years, that new car will have lost 60% of its value. Poof! The value that remains constant is your monthly payment, which can feel like a ball and chain once that new car smell fades.
The Lesson: ‘Buy a used car you can easily afford and get excited about. Then one day when you have saved enough money, you might be able to buy your dream car with cash.’
4. Financial retail purchases
The Mistake: ‘Our refrigerator is old and gross – we need a new one with a touch screen – the guy at the store said it will save us hundreds every year. It’s zero down – ZERO DOWN!’
The Realities: Many of these ‘buy on credit, zero down’ offers from appliance stores and other retail outlets count on naive shoppers fueled by the need for instant gratification. ‘Zero down, no payments until after the first year’ sounds good, but accrued or waived interest may often bite back in the end. Credit agreements can include stipulations that if a single payment is missed, the card holder can be required to pay interest dating back to the original purchase date! Shoppers who fall for these deals don’t always read the fine print before signing. Retail store credit cards may be enticing to shoppers who are offered an immediate 10% off their first purchase when they sign up. They might think, ‘I’ll use it to establish credit.’ But that store card can have a high interest rate. Best to think of these cards as putting a tiny little ticking time bomb in your wallet or purse.
The Lesson: ‘Don’t buy on credit what you think you can afford. If you want a ‘smart fridge,’ consider saving up and paying for it in cash. Make your mortgage and car payments on time, every time, if you want to help build your credit.’
5. Going into business with a friend
The Mistake: ‘Why work for a paycheck with people I don’t know? Why not start a business with a friend so I can have fun every day with people I like building something meaningful?’
The Realities: “This trap actually can sound really good at first glance. The truth is, starting a business with a friend can work. Many great companies have been started by two or more chums with a shared vision and an effective combination of skills. If either of the partners isn’t prepared to handle the challenges of entrepreneurship, the outcome might be disastrous, both from a personal and professional standpoint. It can help if inexperienced entrepreneurs are prepared to:
Lose whatever money is contributed as start-up capital
Agree at the outset how conflicts will be resolved
Avoid talking about business while in the company of family and friends
Clearly define roles and responsibilities
Develop a well-thought out operating agreement
The Lesson: ‘Understand that the money, pressures, successes, and failures of business have ruined many great friendships. Consider going into business individually and working together as partners, rather than co-owners.’
6. Signing up for a credit card
The Mistake: ‘I need to build credit and this particular card offers great points and a low annual fee! It will only be used in case of emergency.’
The Reality: There are other ways to establish credit, like paying your rent and car loan payments on time. The average American household carries a credit card balance averaging over $16,000, and the average Canadian owes $22,081 in consumer debt. Credit cards can lead to debt that may take years (or decades) to pay off, especially for young people who are inexperienced with budgeting and managing money. The point programs of credit cards are enticing – kind of like when your grocer congratulates you for saving five bucks for using your VIP shopper card. So how exactly did you save money by spending money?
The Lesson: ‘Learn to discipline yourself to save for things you want to buy and then pay for them with cash. Focus on paying off debt – like student loans and car loans – not going further into the hole. And when you have to get a credit card, make sure to pay it off every month, and look for cards with rewards points. They are, in essence, paying you! But be sure to keep Lesson 5 in mind!’