“Hey—can I borrow $30?”
How many times do families hear that kind of “Can I borrow. . .” question? Many of us feel it is too often. It’s easy to “tend to lend” even when we know our kids are less than dependable credit risks. In the real world, however, getting credit isn’t easy or casual; it’s an important financial literacy lesson and reminder for all of us.
In today’s hectic world, it’s common to foster these “informal no-pay-back loans” for lots of reasons. As those in charge of classrooms and families, however, we need to help prepare our kids to be able to secure credit in the real world—by helping them to understand and form better borrowing habits today. Certain characteristics make you a desirable candidate for a loan and even then, there are many hurdles.
On Day 16 of Financial Literacy Month with FUTURES: Financially Literate Kids for a Financially Literate Society™, we’re talking credit—apart to explain it to kids in easy-to-grasp ways. By explaining to kids that credit is money you borrow from a bank or another similar institution, with a promise to pay it back later, we are beginning to distinguish between the formal criteria for borrowing from an institution and casual family-based loans. With the former, repayment includes interest, or fees on top of the original amount borrowed.
Most people with a mortgage on a home—which is a kind of credit—pay interest on top of the regular loan for a period of 30 or 15 years, or however long they decided when they signed the papers. Credit cards also charge fees when you have a balance, or don’t pay the full amount you charged each month. Sometimes people put too much money on credit cards—or get into debt in other ways—and have trouble paying them back. Understanding how credit works can help you avoid getting into difficult situations.
There’s also something called a credit score that determines how attractive a person comes across as a potential borrower. You don’t have to have the best possible score to get a loan, but it helps to have good credit.
The 5 Cs of Credit
Entrepreneurs often need credit to start their businesses. A bank weighs each factor to determine if it will give a loan to a potential business owner. Here are the 5Cs a loaning institution considers before agreeing to give a person or new business credit:
Capacity: Measures a borrower’s ability to repay a loan by comparing income to recurring debts.
Capital: Refers to a borrower’s reputation or track record for repaying debts. This is sometimes referred to as credit history.
Character: Any funds the borrower puts toward the potential investment.
Collateral: Any property or other asset that a borrow offers as a way to secure a loan. If the borrower shops the promised loan payments, the lender can seize the collateral as payment.
Conditions: The conditions of a loan, such as its interest rate and amount of principal, influence a lender’s decision to make a loan to the borrower.
Play the Credit Qualifying Game!
This entrepreneurial activity might completely overhaul the next “Can I borrow $30?” discussion in your home or serve as a strong role-play activity in school. Kids of all ages can play this game—pair the youngest kids with the oldest if they need help participating.
Consider the following 15 scenarios in terms of the 5Cs of Credit: Capacity, Capital, Character, Collateral, and Conditions. Think of it like a matching or memory game.
For a bonus, choose any three or four scenarios randomly, and then have kids decide whether they would give a candidate with those characteristics a loan if they were a bank or lending institution. Kids can even role play, applicant, lender, and entrepreneur to underscore the scenarios.
Visit Us Every Day in April
Check back tomorrow as we continue Financial Literacy Month with a post on revenue and cash flow that uses some mouth-watering examples.
For more information about FUTURES: Financially Literate Kids for a Financially Literate Society™ for students in kindergarten through eighth grade or to download any of the 29 sections of the program, please click below.