My daughter repays a financial debt and learns the concept of interest

School fairs are a great way for the community to come together to raise money for my daughter’s school. For this occasion, I gave her $30 to buy 20 tickets (at $1 each) for shows and attractions and $10  to buy a burger and drink plus a cookie or candy. She wanted to use $10 from her own allowance as well. So, with $40 in her little crossbody purse, she was good to go and the money was supposed to last 4 hours.  She’ll be with her friends and had free reign of the whole school supervised by the entire faculty and parent community. Knowing that she’ll have a great time on her own, I took the opportunity to slip away to run some personal errands. But before leaving my daughter, I quietly gave an extra $20 “emergency” money to one of the parents who was supervising.

The afternoon rolled by, and as things were winding down, my daughter greeted me with painted face, sweaty, matted hair, fully exhausted with a full belly. She also had a bag of loot to take home.  I asked how her budgeting turned out. I spent all the money! Did you have lunch? Yeah, but I had to borrow money from my friend’s mom. Really?!? This was a bit concerning on at least two levels: she went over budget and was brazen enough to ask for (or expected) a loan.

I give my daughter an allowance not to reward her for chores done, but as a method of teaching her the concept of money: saving and spending. Her school also teaches rudimentary ideas of money when they learn about trade and reciprocity through stories. But because she’s now borrowed money (from the parent I slipped the $20 to), she’s actually opened the door to a new level of discussion on finances. I guess this is a good thing because on our own, I would never (at this age) have lent her money to elevate the discussion on debt and interest.

For a kid whose subsidized income (allowance) is $1/day, paying back that dime works out to be 10% of the wages earned for that day — all for the privilege of borrowing a little bit of money for two weeks in order to buy something unnecessary! My daughter was beginning to understand that borrowing money wasn’t as simple as borrowing a toy or a book.

The amount of money a person can borrow depends upon how much money they have or can make to meet a repayment plan. This is critical since loans are not entitlements and the amount or principal, interest and term can vary. Since my daughter makes no money other than a subsidiary (allowance) she would normally not qualify for a loan. This was a surprise to her! My next revelation addressed the cost of borrowing. My daughter thought that she would only need to repay the borrowed amount. No! When someone lends you money, they don’t have that money to use anymore. You, as the borrower, have the privilege of doing or buying something that you couldn’t without the loan, so you have to pay for this benefit. How much ‘extra’? she asked. This is called interest and it changes. You would have to pay it back within a set period of time. This is called the term. I used our own mortgage as an example. Since daddy didn’t have enough money to buy the whole house free and clear when we moved in, I had to go and borrow money from the bank to pay off the house, little by little over time, while we are living in it.

My daughter was gradually beginning to understand that borrowing money wasn’t as simple as borrowing a toy or a book. At a high level I went through the math with her. Borrowing $20 at 5% for 2 week term and comes to 3.8 cents which I rounded to a nickel.  The next time she sees her friend and her mom, (which could be a month), she’ll need to pay back the original $20 (she actually thought I would pay it for her! Ha ha. No!) and the extra dime. Then reality set in on my daughter. From her perspective, for a kid whose subsidized income in the form of an allowance is $1/day, paying back that dime works out to be 10% of the wages earned for that day — all for the privilege of borrowing $20 for two weeks in order to buy something unnecessary.  As we counted all her bills, quarters, nickels and dimes and even a handful of pennies, she realized the ‘cost’ of borrowing.

When she saw the friend’s mom, she handed the money over and we had a brief chat about repayment and interest. The mom thanked her and behind my daughter’s back, gave the envelope back to me with a wink. Behind my daughter’s back, I put that money back in her piggy bank, interest and all. The total cost of this lesson: $20.10. The value of the lesson: priceless.