When your child asks for a loan, should you say yes?

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If your adult child asks you for a loan, don’t pull out your checkbook until you’ve examined the financial and emotional costs. Consider these key questions:

Why does your child need the money?
If your child is a chronic borrower, frequently overspends, or wants to use the money to pay past-due bills, watch out. You might be enabling poor financial decision-making. On the other hand, if your child is usually responsible and needs the money for a purpose you support, you may feel better about agreeing to the loan.

Can you really afford it?
Perhaps you can afford to lend money right now, but look ahead a bit. What will happen if you find yourself in unexpected financial circumstances before the loan is repaid? If you decide to loan your child money, be sure it’s an amount you could afford to lose, and don’t take money from your retirement account.

What if something goes wrong?
One potential downside to loaning your child money is the family tension it may cause. When a financial institution loans money to someone, it’s all business, and the repayment terms are clear-cut. When you loan money to a relative, it’s personal, and if expectations aren’t met, both your finances and your relationship with your child may be at risk.

If you decide to say yes
Think like a lender. Take your responsibility, and the borrower’s, seriously. Putting loan terms in writing sounds too businesslike to some parents, but doing so can help set expectations. You can draft a loan contract spelling out the loan amount, interest rate, and a repayment schedule. To avoid playing the role of parent-turned-debt-collector, consider asking your child to set up automatic monthly transfers from his or her account to yours.

Pay attention to some rules
Having loan documentation may also be necessary to meet IRS requirements. If you’re lending your child a significant amount, prepare a promissory note detailing the loan amount, repayment schedule, collateral, and loan terms. Include an interest rate that is at least equal to the applicable federal rate set by the IRS. Doing so may help ensure the IRS doesn’t deem the loan a gift and potentially subject you to gift and estate tax consequences. There may also be certain requirements if the loan will be used for a home down payment or a mortgage. The rules and consequences can be complex, so ask a legal or tax professional for information on your individual circumstances.

If you decide to say no
Consider offering other types of help. Your support matters to your child, even if it doesn’t come in the form of a loan. For example, you might consider offering a smaller, no-strings-attached gift to your child that doesn’t have to be repaid, or offer to pay a bill or two for a short period of time.

Don’t feel guilty. If you have serious reservations about making the loan, don’t. Remember, your financial stability is just as important as your child’s, and a healthy relationship is something money can’t buy.

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2016.

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