The Bank of Mum and Dad

Posted by David G. Evans

The relationship between parents and children around money can have a profound effect upon a child's financial independence in later life. Properly done, a child can develop habits that will guide them through adulthood. Done poorly, parents may never escape being the Bank of Mum and Dad.

The Bank of Mum and Dad

The Bank of Mum and Dad (BOMAD) has been in the news a lot as a result of this paper. BOMAD is famous in the mortgage market for its 0% interest rates, flexible repayment terms and indefinite extension options.

 

BOMAD will be involved in a staggering 25% of all UK mortgage transactions and so not surprising that most articles around this subject have (narrowly) focused on parents helping their children onto the property ladder.

In my view this is rather unfair and shortsighted. BOMAD, which usually traces its foundations back to the birth of the first born, has been operating behind the scenes for many years. In early times it was more of a simple deposit taking institution, banking cash gifts from family and friends as term deposits that paid a staggering 0%.

As time went on BOMAD diversified into other areas. It became the cashier and auditor of the family benefits scheme (pocket money) and then the Lender of Last Resort (LOLR), there to bail out its customers when no one else would lend them money for emergencies such as movie tickets.

Only in recent years has the LOLR become the most active of all the BOMAD's functions as it moves into mortgage lending. So much so that traditional high street banks are wary of the new competition.

The Importance of BOMAD

BOMAD fills an important role is our society - with property prices a ridiculous multiple of the average wage, it is inescapable that BOMAD will have to help children onto the property ladder.

However BOMAD has the potential to help children well before they even consider a life outside the family home. The importance of the relationship between parents and children around money cannot be underestimated. The lessons that can be taught through the day to day operations of BOMAD can have a significantly beneficial influence and help guide children through life. Not seizing the opportunity today is not just missing an opportunity, its missing an opportunity when the cost or downside is very small.

Here are a few ideas on how to get the most out of BOMAD.

 

Have you signed up for HootLoot?

 
 

The Importance of Being Real

Bank accounts are not free and banks are not charities. Having a current account with a positive balance may not cost you anything to hold, however overspend, travel overseas, miss a payment or any of the other ways that will incur a charge and quickly you'll see where else they make their money.

Understanding how banks and financial institutions make money is a good start. How many university students racked up debt and shuffled balances on the Ponzi credit card scheme only to find out the real cost too late. Not one that I know would do it again.

 

 

Helping children to understand this will help avoid costly mistakes and higher interest charges in the future. Having an idea of where the profit comes from is very useful in evaluating whether it is the right product for you. If something seems too good to be true, then it most likely is – as the financial crisis demonstrated.

Pay Interest

Interest is a powerful thing, but it cuts both ways. The sooner they understand the Power of Compounding, the sooner they can get it to work for them not against them. Unfortunately we currently live in a no interest world on deposits, but that doesn't mean that BOMAD cannot pay a better rate to its VIP customers.

Pay Interest... on Savings

Distinguish between spending money and savings. Only pay interest on savings. Of course children will say everything is savings until the point they spend it, but I'll leave the compliance to you to deal with.

 

Spending and Saving on HootLoot

 

In HootLoot, we get around this by classifying savings as the money allocated to savings goals. This is what you can pay them interest on. Otherwise it is Spending Money – money that is currently available for a child to spend. Using HootLoot, a child cannot simply reallocate money around as they see fit, in the same way we cannot make a pension fund contribution and then decide we want to spend it now. Having a clear understanding of the purpose of money helps avoid those “double counting mistakes”.

Charge Interest on Borrowings

Time to get a little controversial... Everyone has a view on this, here's mine. If they borrow money from you, you should charge them a rate of interest. How else will they learn about the true cost of money? (Of course you'll secretly put it in their long term savings account.)

If you want to really teach them a lesson – adjust the interest rate based upon whether they have repaid prior loans on time. Just like a real bank does. Help them understand the financial consequences of their behaviour.

Make Sure They Repay

Letting them off a loan may seem like a nice thing to do, but what does it teach them? In the real world being 'let off' a loan usually means bankruptcy - not something that anyone really wants. If they borrow money from BOMAD, make sure they repay it. This doesn't stop you from giving it back to them as a present or contribution towards something, but it does get them to understand that in the real world loans need to be repaid. 

Reward the Right Behaviour

What do we, as parents, want regarding money? For myself, I would like to see a demonstration of maturity towards money. Of course its a relative concept, so factors such as pocket money not being immediately spent, saving up towards anything (delayed gratification) and learning to prioritise their unlimited wants. As they get older I would like to see them asking themselves how much they really want or need something before they blow all their cash on impulse purchases.

These are also the types of behaviours that I will reward. A common reward scheme is the matching of savings, but it is a personal choice - you choose what behaviour you want to encourage and how to reward and encourage it.

The right kind of behaviour?

Dealing With The Wrong Behaviour

What does a child learn when they spend all their pocket money on the first day and then gets handouts from parents to cover them to next week? Either that their parents are out of touch with the current cost of living for a child, or that they can spend what they like as they're always going to get bailed out. Where and how exactly does this end?

I can point to parents of young adults who still cannot answer this question. The point is that the younger the child is, the easier it is to deal with it and the better off everyone will be in the long run.

Make Them Accountable

Whether it is individuals or companies, one of the big issues and downfalls I regularly see is not knowing where money is coming from and going to. Cut this whatever way you like, but “cashflow is king”. You can tell your children how much money BOMAD is holding on their behalf, or how much interest they will receive, but isn't it better that they take ownership?

make them accountable

 

Make them run their own accounts and be the ones presenting you with the figures of what pocket money is due, how much you are holding on their behalf etc. (Hint: You may want to run your own numbers on this one... just in case ;)

Dealing With The 18 Year Old

It's not just about dealing with banks, mortgages and other financial institutions later in life. Consider the JISA / CTF jackpot that some fortunate children will receive upon turning 18. Getting children onto the right financial path, however you define it, will also help them deal with the issue of when they turn 18 and are now proud owners of a funded ISA account.

Give them some responsibility over the investment decision when they are old enough and they may stop viewing it as a pot of cash to blow on parties and alcohol.

Its Up To You

The money relationship between you and your children is ultimately up to you. If you're like me, you can see it as a great learning opportunity and a way to get them on the right financial path. Do it wrong and you may never escape the role of Lender of Last Resort.

 

What are you waiting for?

 
 

 
 

 

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