- Bargaineering - http://www.bargaineering.com/articles -

Should You Charge Your Child Interest on Loans?

Not 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 [3]. 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 [4] 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:

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 [5] and other unsavory types.

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

(Photo: neubie [6])