Debt can be an overwhelming, confusing part of our financial lives as adults. To say it’s widespread is an understatement. More than half of college graduates have educational debt, and borrow a whopping $28,500 on average. As with student loans, debt isn’t necessarily a bad thing. It’s enabling people to get educations, which may later help them boost their income, or in the case of a mortgage,it allows them to buy an asset that hopefully rises in value.
But not all debt is “good”: the average American carries thousands of dollars of credit card debt. And that can come from expenses ranging from covering medical bills to trivial things like eating out excessively or retail therapy. It can spiral into increased debt as interest accumulates while payments towards it don’t.
Regardless of the source, though, debt is a reality which adults have to face. And it’s better to raise kids to be prepared for the likely event they do have to manage debt than the unreasonable sentiment that they should never take on any. So how can we break it down for kids to understand? This debt simulator activity should help.
Before engaging your kids in the activity, have a conversation about what debt is and what key points to keep in mind. Make sure your talk is age-appropriate. Use kid-friendly language—no hard-to-grasp terminology—and examples they can relate to from their day to day life.
Here are all the steps you need to explain debt to kids and to start the debt simulator money game:
Start by explaining that it’s important to try and make sure to pay for things with money you have, but that sometimes grown-ups have to pay for some things but they don’t have the money to do so. Share that borrowing money helps us make these purchases or paying unexpected expenses that happen because of emergencies.
Then, share that some loans pay off in the long-term because they are for important items that grow in value over time (like a house or college education). And sometimes, the expense could be an unexpected emergency which we need to save up to pay back.
Explain that adults can borrow money from the bank—how kids might borrow a toy from a friend. Just like with a toy, you know you have to give it back eventually. But, unlike a toy, repaying a loan often involves paying “interest”, too. This just means paying a little extra for the privilege of taking out the loan and the risk that the bank takes by lending it to you. (If your child knows about fractions or percentages, you can use these concepts when discussing interest.)
Finally, share the downside of taking out a loan is that, you’ll end up spending more than the cost of the item you’re borrowing to buy, because of interest. That’s why you have to be careful with debt and to try to only use it if it’s worth it and you can eventually pay it back!
Don’t forget to bring up things like hidden fees, like annual fees for credit cards that kick in the second year. These can be tricky, and they add up over time!
What is a purchase your kid really wants to make but can’t afford? Maybe they’ve got their eyes on a new videogame. Help them research how much it costs and calculate how much they need to borrow to pay for it.
Just like with a real loan, start with a contract. Write down the “terms” on a piece of paper: they get x amount of money for y amount of time, and have to pay z interest per day or week it takes them to repay the loan. You can even had an addendum about late payments incurring an extra fee! Have everybody sign on the dotted line and hand over the agreed upon sum in cash.
Loan amount: $_____
Time to repay: _____ weeks/months (circle one)
Interest rate: _____%/______week/month (circle one)
Late payment fee: $____
In order to pay back the loan with interest, they’ll need an “income.” Set up a series of extra chores or an allowance system they’ll have to abide by, if they don’t already have some. They can use the money they “earn” to make payments.
This is key: make sure to collect loan and interest payments on time, just like a real bank. The fact that these payments and deadlines are non-negotiable is one of the most important parts of the lesson. Every day, take one nickel back, as a “loan payment.”
Optional: to teach kids about compound interest, increase the loan payment every other day by $0.01, $0.10, or another simple amount.
When you collect loan payments, keep the loan separate from the interest payments in two clear glass jars. At the end of the week, count up how much they paid in interest, and talk about how what that amount could have bought if it wasn’t used up on interest. Explain that if they hadn’t taken out a loan, they would have avoided paying interest, and could’ve used the money they earned on something else. This is why making purchases only when you can afford them up front can be a good idea. Talk about how loans aren’t “free money” and they mean making long-term sacrifices after taking them out to make a purchase now.
You can also do this simulator with jelly beans or another type of candy, or play money instead of money and coins. But using real money will really drive the concept home. Or, if your kid is older, you can have them check out online debt simulators that play with larger amounts of money, longer time periods, and varying interest rates and fees.
Like with all experiential learning games, the education doesn’t just come from the activity itself, but from the conversations you and your child having reflected on it. Be patient with them if they get frustrated—remember, debt is frustrating for adults, too! Better to have them learn in a controlled environment than make more costly mistakes in the real world down the road.