Debt: The old ball and chain

Updated April 27, 2023

Debt.  A little word with a lot of weight.  Kids hear their adults throw this term around, but they often have a shaky sense for what it actually means.  Debts are a fact of life for 80% of American adults, and the average American carries a personal debt of $92,727.  From mortgages to student loans to credit card debt, there’s no doubt we collectively owe a lot of dough. 

So what does this mean for our kids? Kids need to understand the ins and outs of debt to know when and how to borrow as they grow.  Since the vast majority of their grown-ups carry a debt of some kind, now's the time to give kids a glimpse of the good, the bad and the ugly of borrowing money.

W.K.S.K (What Kids Should Know)

Define Debt For your Child

What is debt anyway? Debt is when you owe money to another person or place. For example, if you borrow $4 from your brother to buy two scoops of strawberry ice cream, you need to pay him back when you have the $4 on hand.  However, if your brother was savvy, he’d even add a little interest, or an additional charge for lending the money.  Interest is calculated as a percentage of the overall loan and makes borrowed money more expensive to pay back.  

Once kids understand what debt actually is, how do we help them get debt-savvy?  It can happen in just three simple steps:

1  Let kids practice borrowing money in low-risk ways.

2 Include your child in the conversation as we pay off some of our own debts.

3 Ensure your kids are familiar with the three most common forms of debt (keep reading to get more on this).

Let Them Practice Borrowing...And Paying Back

The best way to help kids understand debt is to let them borrow money from a parent and keep them accountable for paying it back.  Let’s imagine your nine-year-old is begging for the latest video game.  He’s accumulated some spending dollars from his allowance, but is still $20 short.  With no birthday or holiday in sight, you might consider loaning him the $20 difference...but with a caveat.  Draft an IOU that lays out the terms of the loan and be sure to charge interest. 

For example, if you agree that your son has a month to repay his debt, perhaps he might pay $5, plus 10% interest (50 cents!) for a total $5.50 each week. (Now that $20 video game loan costs $22!) Not only will your kiddo undoubtedly gain valuable practice repaying debts owed, but he might think twice about borrowing unnecessarily in the future.  

Make Them Part of The Debt Conversation

Another easy way to teach kids about debt is to give them a glimpse of the debts their parents might be paying off.  Of course, no full financial disclosure is necessary, but looping kids in on the conversation around mortgage payments, student loan commitments or credit card statements might give them insight into the good, the bad and the ugly of borrowing. 

Like all things money related, keep the conversation simple, “Dad and I borrowed some money from the bank to buy our family home eight years ago.  Each month, we pay the bank a small amount back.  Over time, we will have paid for the whole house!”  

With a basic understanding of debt and interest, it's important to look at the different kinds of debt that people take on.  Want to be a debt master? Let’s break down the three most common forms of debt we might encounter.

The Three Most Common Forms of Debt

1. Mortgage

One of the most common forms of debt is a mortgage.  Because homes are expensive, most people don’t have enough cash on hand to pay for their apartment or house outright.  Instead, they borrow money from a bank and slowly pay the bank back over time in small installments. 

A mortgage is a form of secure debt, which means borrowers use collateral, or something that can be taken away if they don’t pay their loan back.  In short, if the borrower fails to make his mortgage payments, the bank has the right to take over the property and sell it to pay off the debts owed.  This is called defaulting on a loan, or failing to repay debts.  Because secured loans are backed up by collateral (like the house in this example!), they allow people to borrow a large sum of money, the requirements are less onerous for the borrower and interest rates are typically lower. 

Mortgages can be a beneficial kind of loan, as they help families purchase a home without needing to save up such a large sum of money in advance. 

2. Student Loans

Since college and graduate school is very expensive, many young people take out student loans to pay for their tuition, living expenses and school supplies.  Unlike mortgages, student loans are not backed up by any collateral. This is called an unsecured debt. 

Unsecured debts such as student loans are based on creditworthiness, or the lender’s trust that the borrower can repay what they owe.  The lender and the borrower enter a contract to agree that the loan will be repaid.  Because these debts are much more risky, the interest rates are typically higher (making the initial loan more expensive to pay off). 

While student loans currently help over 43 million student borrowers pay for their higher education, these students owe an average debt of $39,351 each following their graduation.  Unless graduates get a high-paying job after college, these loans can take many years to pay off.  

3. Credit Card Debt

Ok, debt masters, let’s get fancy.  Another common form of debt is credit card debt.  Credit card debt occurs when people charge more expenses on their credit card than they are able to pay back.  Because interest rates are so high on credit cards, it gets harder and harder to repay credit card debt the longer it accumulates. 

Credit card debt is a form of revolving debt, which allows consumers to borrow money on a recurring basis and only pay a monthly minimum.  Credit card companies let borrowers continuously spend up to a specified limit before they have to start repaying the money.  Considering that the average credit card interest rate was over 18% in 2022, Americans owed about $1155 last year in interest alone.  Let that sink in a moment.  

Benji’s Bottom Line

Teaching kids about the costs and benefits of borrowing money (debt) is an essential part of building their financial fitness. It is critical that kids understand that their debt track record will follow them far into the future.

If parents can prep kids to be money-smart borrowers, they may avoid serious financial stress later in life. By practicing responsible borrowing, recognizing their parents’ debts, and identifying the most common forms of debt, kids will be well on their way to becoming debt masters in the future.

Is it bad to borrow money and take on debt? What are some circumstances when it might be smart to borrow money, and what are some times when you should try to avoid it?