Money Talk Series: Part 3

Our journey began with distinguishing between necessities and luxuries.

Next, we explored the principles of budgeting.

Now, let's unravel the complexities of debt.

Debt can be perplexing, akin to a strategic board game. A wrong move can lead to problems, but the right strategy can yield substantial benefits.

For parents struggling to explain debt to children, I'm here to assist.

Remember, not all debts are the same. Borrowing isn't inherently negative.

Chances are, you're among the 60% of Americans with a home loan. If you bought or refinanced at the right time, you might enjoy a low interest rate below 3%.

However, using a high-interest credit card for impulsive purchases like a new iPhone could be a financial misstep.

The prefrontal cortex, which governs logical decision-making, isn't fully developed until around 25 years old. Therefore, expecting teenagers and young adults to independently make savvy debt decisions might be unrealistic.

Yet, here they are, acquiring student loans and financing various gadgets.

Assessing debt choices can be straightforward. Teaching your child how to do a cost-benefit analysis could provide you with peace of mind.

Let's explore how to impart this skill to them, starting with the student loan conundrum.
🎓 The student loan dilemma

Let's delve into the frequently discussed topic of student loan debt.

Cost Analysis: Imagine a student loan of $30,000 with a 5% simple interest rate, to be paid off in 10 years. This would amount to a total repayment of $38,184, equating to $318 monthly after graduation.

Benefit Assessment: Generally, holding a bachelor’s degree can enhance lifetime earnings by approximately $550,000, which translates to an extra ~$1,146 every month.

Evaluating the Trade-off: The potential increase in income seems to surpass the loan cost, and the monthly loan payment is lower than the expected monthly income boost.

Potential Risks: It's important to acknowledge the uncertainty in the degree enhancing earning potential, especially in the initial years post-graduation when the loan needs repayment.

Drawing a Conclusion: This appears to be a relatively safe bet. The modest monthly repayment and the total loan amount of $38,000 are considerably less than the anticipated $550,000 lifetime benefit.

However, what happens if the loan amount is $144,000, the current average for a four-year degree?

Keeping other factors constant, this leads to a repayment sum of $183,281, or monthly payments of $1,527 for a decade post-graduation.

Critical Questions:

- Does this still represent a sound investment?

- Is it feasible for a graduate to manage monthly repayments exceeding $1,500?

- In my view, it seems unlikely.

Encourage your teenager to apply this analysis when considering colleges and the associated expenses.

Guide them in calculating loan terms, researching income prospects in their chosen field, and listing all potential risks.

Gadget Investment: Is it a smart choice or a no-go?

There will always be a newer one. Source: Giphy

The allure of the newest gadgets is ever-present, as highlighted by a source from Giphy.

Consider this common dialogue you might have had with your child:

Expense: Buying a new iPhone for $1,000 using a credit card that charges 18% interest, compounded daily.

Many argue this is an unnecessary debt for young people. However, as I pointed out in the first part of our Money Talk series, financial choices aren't always straightforward. Simply telling your child that all debt is bad doesn't foster critical thinking.

Let's examine two different situations.

In both scenarios, assume your child either doesn't have $1,000 in cash or needs to reserve their savings for other expenses like a car or college.

Scenario 1:

- Your child has a stable part-time job, earning $300 monthly. They save $100 each month, leaving $200 for other expenses.

- They plan to pay off the iPhone in a year with monthly installments of $92, requiring a reduction in their other monthly expenditures.

- Even if they miss some work, their income should cover the $92 payment and meet their savings goals.

- The total interest paid would be $84, bringing the overall cost to $1,084.

- This appears reasonable and could be a valuable lesson in budget management.

Scenario 2:

- Your child earns sporadically through odd jobs and receives an allowance.

- They find a deal for the iPhone at $26 monthly.

- They think, “I can manage $26 a month for a new iPhone!”.

- However, with the 18% interest rate compounded, this means:

- Payments of $26 for five years.

- A total interest of $494, making the cost $1,494.

- This isn’t a wise financial choice.

In conclusion, debt is a tool, not a trap, when used judiciously.

It's akin to a lever — use it properly, and you can achieve much more than your apparent capabilities. Teach your children to respect and understand debt, not fear it. Grasping both its advantages and risks equips them for future financial wisdom.

P.S: As we embark on this enlightening journey through the Money Talk Series, we'd like to extend our heartfelt gratitude to for their generous sponsorship. Their support is instrumental in bringing this series to life, offering a treasure trove of knowledge and insights.