Should You Lend Money to Your Kids?
Melissa A. Seamon, CFP®
Financial Advisor
Kids are expensive and after they grow up, money often remains in the picture.
It’s not uncommon for parents to help with groceries, cars, and college tuition. According to the well-known financial institution Merrill (formerly Merrill Lynch), 79% of parents with young adult children provide some type of financial support. When it comes to bigger ticket items, about 60% pay for weddings and 25% help fund their child’s first home.
It’s also not uncommon for adult children to ask for loans from their parents or for parents to offer a loan. Financially supporting your adult children can really add up, but for most parents it’s a no-brainer to help their children no matter what age they are. However, there’s a big difference between giving money and lending money. Here are four main considerations before you lend money to your adult child.
1. Don’t Sacrifice Your Financial Stability
Sacrificing your own needs and wants is a big trait of parenthood, so it can be hard not to come to your child’s rescue when they need “just a little bit more” to buy a new car, purchase a new home, or put their own child through private school. These intentions are all well and good, but you should never put your own financial future at risk in order to make their dream come true.
As a general rule of thumb, only lend money that you won’t miss. In order to test this, you have to consider the worst-case scenario. Would you still be financially secure and on-track to meet your own goals if the loan were never paid back? This is not even to mention, of course, how this could affect your relationship with your child (and your spouse), but we’ll touch more on that below.
2. Set Clear Expectations
Just like you did when your child was young, you have to set clear expectations up front or risk the train going off the rails.
Often, parents loan money to their children for a specific purpose, such as paying off a debt, only to see the funds used in a different manner. Would you be OK with that? How will you feel if your child goes on an electronics spending spree before fully paying you back? Will your child feel judged every time they make a purchase if they still owe you some money? That kind of resentment can tear apart even the closest-knit families.
Agree on terms ahead of time. This includes specifying where the money is going, when funds will be released, and any other stipulations you may have as the grantor. For example, if your child is continually making poor money decisions, you may require that they go through a budgeting class before you loan them the money. Or, if they aren’t using the funds how they stated, perhaps they stand to lose the second installment. To determine a fair interest rate that will safeguard your investment from inflation, you can use the Applicable Federal Rate, which is calculated by the IRS each month.
3. Put Everything in Writing
Once you have agreed on all terms, you’re all set, right? … Wrong. GET. IT. IN. WRITING. You wouldn’t get a loan from a bank without a contract. And there’s a reason “it’s not personal; it’s business” is a popular phrase. By removing the personal component with a formal, legally bound agreement, you’re able to treat the loan like the actual business transaction that it is.
It can be as simple as putting together a free promissory note from LegalZoom or as formal as involving your own lawyer to draw up a contract. Either way, get all of the terms that were agreed upon in there. You don’t want gray areas or unmentioned details to cause family squabbles later on. For example, you could include that any unpaid funds will be deducted from the child’s share of inheritance if that makes you feel more comfortable about the transaction.
4. Stay on the Same Page with Your Spouse
The decision to lend money to your kid to cause conflict in your marriage. Talk through everything from the amount, to the payback terms, to consequences first. If you disagree, talk through compromises, such as giving a smaller loan or providing other kinds of support. Don’t go behind each other’s back as this could cause a deeper rift between all parties.
If you are divorced and still have good communication with your ex, consider filling them in as well. Some children don’t stop pitting parents against each other for their gain once they’re adults. It might change your mind about the loan if your child is also receiving monetary assistance from their other parent.
If you are single, bring in a third party, such as your financial advisor, to get their take on it. Parents rightfully have soft spots for their children, but they can sometimes be blind spots as well. While helping out is in your nature as a parent, sometimes it can be better to let your child stand on their own two feet.
Next Step
For every parent considering giving their adult child a loan, start with a conversation with a financial advisor. In addition to helping you determine your financial health before agreeing to the loan, an advisor can be a helpful third party who plays the bad guy if terms aren’t being met or easily becomes the scapegoat if you say no.
For more information about the comprehensive planning services we provide, we encourage you to take a look around our website, www.gardey.com, and see if we could be a good match. Then, schedule a call with one of our advisors by calling us at 1-800-550-3880. We’d be happy to meet with you.
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