Teaching your children about interest rates – and how they work – is one of the most valuable financial lessons you can give. As adults, their most important transactions will be impacted by interest rates – so it’s really useful to help them understand how interest can both negatively and positively affect their financial health.
What is Interest?
Interest is a two-sided coin (an apt metaphor!). Representing both the cost of borrowing and a reward for saving, interest rates can impact finances in positive and negative ways.
Start on a positive note by explaining to your children that if you put money in a savings account, the bank will pay you some extra money on top (this is known as ‘interest’). How much you’ll be paid depends on the ‘rate’ that is offered and how long you leave your money in the account: the higher the interest rate, the more you’ll be paid.
However, if you’re borrowing money from an institution or person, you’ll experience the other side of interest: because you’ll have to pay an additional sum to that institution for using their money. The higher the interest rate, the more you will pay!
How did it start?
Funnily enough, credit is thought to have existed before physical money – and by many thousands of years! Documents from Sumer (a civilisation that existed around 3000 BC) detail the first known occurrence of credit, and document the process of loaning both grain and metals. This type of ‘loan’ included an early form of interest: for example, farmers who borrowed seeds would have to pay back all the seeds they’d received, plus an additional amount on top, following the harvest.
Interest – and the practices which influenced its existence – evolved over time, and in 1847 the Banque de France made the first attempt to control interest rates through the manipulation of money supply. At this point, it’s important to explain to your children that interest rates are determined by factors outside of our control, and they do fluctuate; however, one thing your children can control is their credit score. A good credit score will improve their chances of accessing the most favourable interest rates available.
Things to Try at Home
Practise makes perfect, as they say – and one of the best ways to grasp the concept of interest rates is to practise with pocket money. Sit down with your child and agree a set amount that they’ll take from their pocket money and set aside each week: this represents their ‘savings’. Explain that for every £1 they save, you’ll add 10p. The more they save, the more interest they’ll earn. During the month, your child should keep track of how much they’re saving; and, at the end of the month, you can count up the total amount together (including the interest).
Once the older children have mastered the concept, you could suggest they research bank accounts. They can check comparison websites for child-friendly bank accounts and work out which offer the best rates of interest. Be sure to go through the small print with them so they’re aware of any stipulations (they might have to leave their money in the account for a certain length of time, for instance; or pay a set amount in each month). Together, you could choose a suitable account and allow them to start saving – and amassing interest – for real.
For younger children, there’s a similar game you can try – but using food instead of money. In the morning or late afternoon, give your child some sweets or pieces of fruit (like grapes) and explain that, if they can refrain from eating them until after lunch/dinner, you’ll add a few more to the stash. This will help impress upon them the importance of saving – and the rewards that come with it!