When a family needs to borrow for college, parents have a prime opportunity to teach their kids about debt. Unfortunately, many student loan borrowers aren’t well-informed about debt.
Often, borrowers don’t research lenders before getting a student loan, according to an April 2020 U.S. News survey. Furthermore, about 41% said they may have regrets about taking out student loans.
“Student loans carry an immense weight and power within your personal finances, and not taking the time to fully understand how they work has the potential for major setbacks in the long term,” says Alyssa Schaefer, chief marketing officer at Laurel Road, a digital lending platform.
Of course, education is key to knowing how to use credit to your advantage. Here’s what you can do to set up your kids for success.
How to Explain Debt to Your College-Age Kids
Even if you don’t take out student loans, college makes a natural segue to teach kids about debt.
“While many students are getting a first taste of freedom and independence, they’re also safely still tethered to home, so college is a perfect time to teach students about debt,” says Andrew Crowell, vice chairman of wealth management at D.A. Davidson Cos. in Los Angeles.
College students receive many credit card offers, and parents can prepare them to use credit responsibly. You can start with a simple definition of debt.
Aditi Shekar, founder and CEO of San Francisco-based Zeta, an online personal finance tool, explains debt this way: “You borrow money today for something you need, with the expectation that you’ll have to pay it back to the person you’re borrowing it from, with interest.”
Your mortgage, if you have one, can provide another good example of debt in action. Use your monthly mortgage statement to explain principal, interest and loan maturity date.
You can discuss broad details of the choices you’ve made, such as terms and timelines, and the reasons you’ve made them, says Mark Schrader, thought leader and financial planning strategist at TIAA.
Giovanni Fernandez, associate professor of finance at Stetson University’s School of Business Administration in DeLand, Florida, likes to use amortization tables – also called amortization schedules – to illustrate the effect of interest on a purchase.
An amortization schedule shows in a table how much principal and interest you will pay each month until a loan is paid off. You can use it to tell you how much you owe at any point in the future.
“Even when a monthly payment seems low, adding up the cost of the entire life of the loan really opens people’s eyes,” Fernandez says.
Teach Good Debt vs. Bad Debt
Not all debt is bad. Student loans are a perfect example.
“If borrowing money helps you earn a degree so you can dramatically increase your income, that’s a great example of using debt to invest in yourself,” Shekar says.
“The important thing here is to try to focus on only taking on good debt versus racking up debt for less value-add items,” Shekar says.
Bad debt is borrowing for purchases that lack lasting value or cause financial hardship. Schaefer says she considers bad debt “a depreciating asset like a car because it won’t increase in value or generate you income.”
How the Coronavirus Affects Student Debt
The coronavirus pandemic has brought relief for some cash-strapped student loan borrowers, but it has not canceled debts.
“One of the biggest effects on student debt is forbearance of federal loans created in the CARES Act,” Schrader says.
The coronavirus rescue package suspends interest charges and monthly payments through Dec. 31 on federal student loans.
However, if you can still afford to pay your loans, you should do so. While no interest accrues, “This is a great opportunity to reduce the principal balance of student loan debt,” says Kim Hardy, certified public accountant and member of the American Institute of CPAs’ National CPA Financial Literacy Commission.
The pandemic has created another chance for savings: Many colleges have frozen tuition during the pandemic, Hardy says.
These discounts have come as colleges have moved online, and some students have opted for gap years to avoid paying full freight for a virtual experience, Crowell says.
Find Teachable Moments to Explain Debt
Start the debt conversation by opening a bank account with a debit card for your child as early as possible, Fernandez suggests. Some banks offer college accounts with parents as co-signers who monitor and guide their use.
“Teaching them how to spend only what is in their bank account will set the tone for credit,” he says.
A healthy next step is to co-sign on a credit card that your college-age kid will be responsible for paying. Just make sure you know how much your child is spending because you’ll both be on the hook for it.
Every time your student gets a statement can become a teachable moment, Fernandez says. Should he or she pay the full balance, the minimum or somewhere in the middle?
“You can run all of the numbers with them to show them the trade-offs,” he says.
When your child decides to purchase a car – or asks you for one – can become another teachable moment. If you decide to help pay for the car, you can create an agreement outlining the terms of your parental loan.
“This will get the child thinking about the true cost of things,” Hardy says.
Talk with your child about a plan for paying you back and budgeting before he or she signs the agreement.
Use Social Media
Social media platforms can be a tool to help young people develop financial literacy.
“The recent explosion of personal finance subcommunities on platforms like Instagram and TikTok make it easy for students to start learning before they set foot in the classroom,” Schaefer says. She recommends My Fab Finance and Clever Girl Finance, which are geared toward women.
You can find more financial resources on social media using the hashtag #personalfinance.
Exemplify Responsible Debt
One of the best ways to teach your college-age kids about debt is to show them through example.
“Sharing aspects of the family budgeting and planning can help to instill good habits at an early age,” Crowell says.
A core tenet of responsible debt ownership is never to borrow more than you can pay back.
Impress upon children to “only borrow or use credit cards after determining how they will repay the debt” in the proper amount and on time, Hardy says.