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Should You Charge Your Child Interest on Loans?

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Loaning moneyNot too long ago, my son wanted to buy a book. He only had about half the money he needed, since he had recently made a larger purchase. For the first time ever, he asked me if he could borrow the money, and then pay me back. I was hesitant, because I don’t like the idea of teaching him that he can just get money for things he wants now by borrowing.

However, after some thought, I decided that this could be a good learning experience. I explained that, like Monopoly, if he’s going to borrow money, he’s going to have to pay extra in interest. So, even though he was borrowing $7, he would need to repay me $8. I told him it would come out of his allowance (after he paid his charity donation and savings), and he had to repay the debt before he could buy anything else.

He agreed, and has been kind of bummed ever since. Instead of watching money grow in his spending jar each week, he has to give all his money over to other obligations. Even worse, in his eyes, is the fact that it’s taking longer to repay me because he owes an extra dollar in interest. An extra dollar! That dollar is going right to my pocket for me to buy candy, instead of him being able to get that big candy bar he wanted the other day.

Right now, he is making grand declarations of never borrowing again. The whole exercise has made a big impression. Hopefully, we won’t have repeats of this borrowing situation later on because of this experience. However, if he does ask to borrow money later, there is a good chance that interest will be charged.

Writing a Loan Contract for Your Child

Many parents charge their children interest for loans, whether it’s a loan so they can buy concert tickets, or whether it’s so that they can purchase a first car. My son and I didn’t have a loan contract, but for older children, including adult children who might regularly ask you for money, a personal loan contract can be a good idea.

Writing a loan contract can establish the terms of the loan ahead of time, so that all parties understand what is expected. You can find free templates online that can help you see how to set up such a contract. However, some of the common elements found in personal loan agreements might include:

  • Names and addresses of included parties
  • Date of the contract
  • Amount of the loan principal
  • Interest terms (simple, compound, etc.), including interest rate
  • Total amount to be repaid
  • Total time to repay the loan
  • Repayment schedule
  • Repayment method (cash, services, etc.)
  • Any items used for collateral

In some cases, parents choose to simplify matters by simply stating a total repayment amount, and the repayment schedule. As long as everyone agrees to the terms, it shouldn’t be a problem. Your child should sign and date the contract, and you should as well. If you really want to make an impression, you can have the contract notarized. It doesn’t cost very much, and your financial institution might offer the services of a notary for free to account holders.

In any case, charging interest can be a way to help your child learn a valuable lesson, while at the same time keeping him or her from turning to payday lenders and other unsavory types.

What do you think? Would you charge your child interest on a loan?

(Photo: neubie)

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22 Responses to “Should You Charge Your Child Interest on Loans?”

  1. Anonymous says:

    My parents gave me a loan with simple interest to buy a car when I was 16. Once it was paid off, they surprised me by transferring the interest into my college fund. It helped me learn about interest and also about setting aside a budget for my monthly payments; and it gave me a little extra book money.

  2. Martha says:

    When I was a little girl I had a lemonade stand; my mom would loan me the money to buy the lemonade (and popcorn!) and I would just repaid her when I was done for the day. She never charged me interest but 5% on $1 worth of lemonade wouldn’t have been very much.

  3. Matt says:

    No,I wouldn’t charge interest to my kids. I would just tell them to wait until they have enough saved up to buy it at once, I think that would teach a better lesson.

  4. daenyll says:

    wants (candy, clothes other than basics) had interests attached, needs (such as stuff required for extracurricular activities) were simple repayment when I was a kid. And yes, we paid for our own optional activities whether sports or clubs or whatever.

  5. Modest Money says:

    I think this is a great idea as a one time thing. Kids need to learn their financial lessons. If they can learn from a small loan as a child, that is much better than later making that mistake with an expensive car or other unnecessary loan. With any luck, that lesson will stick with him for life. The fact that it was a book in this case probably made it easier to agree to a loan rather than making him wait.

  6. Charge your kids interest? Haha I’m a cheap SOB, but even I wouldn’t do that..

  7. Lesson learned, I guess, but I hope you find a way to sneak that $1 of interest back into your son’s piggy bank. :-)

  8. James says:

    That’s a heck of a loan racket you’ve got going there… assuming $1 per week allowance, the loan is paid back in 8 weeks, for an annual rate of return of around 240%.

  9. timparker says:

    If your kid is an adult, you may have to charge them interest to avoid gift taxes if it’s over a certain amount although there are ways to get around it.

  10. rlaw100 says:

    14% Interest over a couple of days? They really might be better off going to a payday lender.

  11. Shirley says:

    Twenty-some years ago my daughter and son-in-law were ready to buy their first home and needed to show a substantial amount in their checking account. We lent them the money and three months later they paid it back in full with interest, saying that would have been the amount we would have accrued had it been in an interest bearing account. That young man had some good financial lessons while growing up!

    • Scott says:

      Defrauding a bank = bad financial lesson

      • Shirley says:

        They knew for sure that they had the money coming in, just not in time for the closing. Otherwise we probably would not have made the loan. There was no fraud taking place since they were not required to say where the money came from.

  12. Frugal says:

    It’s a good lesson if it works – be on the lookout for any turn-offs and yes I will give the interest back to the kid as part of B’day gift

  13. Alan says:

    My dad didn’t want me to finance a car through the dealership so he paid for the car and I pay him back within 5 years + inflation.

  14. AndrewB says:

    I’ve taken two 8 year loans from my parents to purchase rental property. I setup the loans in LendingKarma.com for $60ea, with interest payable above the IRS rates at the time so it would not be considered a gift. I benefited with low cost loans that would have cost more in interest and closing fees if I went through a bank, and my parents benefited by getting a higher interest rate than the bank would have given them in a CD.
    I have never missed a loan payment in the 3 years we set this up. If there were a shortfall in rental income the monthly payments would have to come from my emergency fund or elsewhere.

  15. Nick says:

    I trust that as a loving caring Role Model Father that you will show your son your Income Tax Return wherein you claimed the interest income and paid both your State and Federal Income taxes.

  16. Susan says:

    I have really strong feelings about this subject. My dad always charged me interest when I borrowed money. When I was a kid my friends all thought my parents were so cold, but I really learned to be cognizant about my money and how I use it. As an adult I’ve borrowed money from my parents and felt good about the fact that they were earning interest on the loan; that it was mutually beneficial. I also have pretty good financial skills and a sky-high credit rating, and I think my dad’s practice of charging me interest for loans gets a lot of credit (no pun intended) for that. I think charging your kids interest on loans does nothing but good, and not to do so is potentially harmful in the long run. Here’s an opportunity to learn these lessons in a comfortable, controlled environment, as opposed to finding yourself in the big, cold world and in financial trouble with no skills, and suddenly learning the world doesn’t hand you everything you want for free. We may not always be there for our kids, God forbid it be sooner rather than later, but we need to be sure they have the skills they need to thrive out there.

  17. Anonymous says:

    At what age do kids need to learn all this? why are we doing this again? to teach the kid a lesson or simply because we are deciding to treating kids like any other person? If my 10 year old son wants to buy a book, i just let him buy it from his weekly allowance… If he ran out of his weekely allowance I make him wait till next week. Unless he is a full grown up with his own life and job, why would i treat him as such? If he is living under my roof and still dependent on me, then its my job to provide for him no? Otherwise why bring kids into this world?

  18. Olivia says:

    I wish my own parents had taught me about life and finances before sending me off. It’s frightening to struggle without a net. We’re actively instructing our kids (however imperfectly). At least they’ll have something to improve upon.

  19. Awesome post Miranda!

    I love this idea for helping our kids learn a valuable lesson! I’ve got a daughter who is almost 14, one who is 10 and a 4 year old son, and I certainly don’t want them to make the same mistakes my husband and I made in the past, regarding credit card debt. It’s been a journey and a half digging our way out of it.

    I’m proud that they’ve witnessed us correcting our decision making process and getting creative with our money to make ends meet without resorting to credit cards through difficult times as we did in the past. Hopefully it will keep them from falling into the trap of debt.

    I wish we’d been given the gift of this lesson earlier in life as well.

    Kudos to you!
    Heather

  20. Keith says:

    My brother and I were both told by our father that he would help us with down payments on our houses if we bought them in the same town he and our mother lived in. He would help with the down payment and we were to give him our tax return till the debt was paid off. What we weren’t told was that he would be charging us interest. When I went to pay off the remainder of what I owed, he told me that I owed him more because the interest increased the amount.

    Beyond that, I found that he had taken any expense that he had helped me with (asked for or not). Once when I was out of town on business and couldn’t afford to fix a fender on my car, he took it to a body shop and paid for them to fix it without consulting me. I was appreciative at the time but later had to pay him back with interest. He had written down that expense along with any other simple expense that he had helped with for about 10 years and showed it to me when I was about 33 and a single father.
    He and my mother worked jobs from the time they were in their early 20′s till they retired. At that time, I was laid off from the same company for the 3rd time.

    I will help my children in any way that I can. I will loan them money (without interest) when they need the help.

    Banks charge interest to make a profit.
    If you charge your children interest, it’s for no other reason than to make a profit no matter what you tell yourself and others. No matter how you yell it from the mountain tops that it is okay… it’s wrong!

    For a small amount when they are young and you’re teaching them how loans work, it’s fine. But when it’s for thousands of dollars when they are in a tough spot?… No.

    My children have seen me struggle and I’ve taught them the value (lesson) about borrowing money without burdening them for my own profit.

    You shouldn’t physically abuse your children
    You shouldn’t mentally abuse your children
    You shouldn’t exploit your children for profit


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