ASK NEALE: My Adult Son Owes Me Money
"The Golden Rules of Loaning Money to Adult Children"
Reprinted from LearnVest.com
by Cathie Ericson
When you think about the price of having kids, the costs that come to mind may include things like child care, camp, braces and college tuition.
What probably doesn’t spring to mind are mortgages, car payments or personal loans.
The reality, however, is that your bank account will likely continue to be tapped long past the day your kids turn 21. According to a 2015 Pew Research Center report, six in 10 Americans with at least one adult child say they’ve provided their kids with some financial support within the past year.
And the dollar amounts they doled out were probably a bit steeper than $100 here or $500 there: A 2015 TD Ameritrade survey found that parents supporting adult kids gave them an average of $10,000 over the past 12 months.
When dealing with lending money to family, it’s very possible that parents expect to be paid back at some point. But entering into parent-child lending territory can be fraught with complications that could lead to big financial burdens and broken family ties.
So we rounded up some financial pros to provide tips on how to loan your adult children money in a way that helps minimize monetary strife and keep family drama at bay.
- Only Lend Money You Won’t Miss
Your child is just a few thousand dollars shy of a down payment on her dream home, and you’d really like to help her get into that three-bedroom Colonial. Before you reach for your checkbook, however, make sure it’s an amount you can stand to part with, rather than money you need for your own financial stability.
“The question I ask my clients [who are faced with lending to kids] is: ‘Are you willing to lose the money?’ If you can’t answer with a resounding yes, then I suggest you don’t loan the money,” says Tom Till, owner of APPS Financial Group, a financial advisory firm located near Houston.
And that advice doesn’t apply just to funds you use to pay your monthly bills; it’s also applicable to any money you’re setting aside for your future.
“If you don’t have enough in savings or retirement or haven’t reached your personal goals, then tell them you can’t help them at this time,” suggests Debbi King, a personal finance and life coach and author of “The ABC's of Personal Finance: 26 Essential Keys to Winning With Your Money.” “Don’t mortgage your future and put it at risk.”
If you still get the pleading looks, explain your no in a way that shows why your financial stability can actually be a good thing for them. One client of Till’s used this approach to tell her daughter why she couldn’t lend her money for a home down payment: “She told her child that I had recommended against the loan because it would greatly affect her retirement income — even to the point where she might have to move in with the child at her new home.”
- Be Clear on How Your Kids Will Use the Funds
You think you’re lending your child money to help pay off a student loan, but you suddenly notice some sweet electronics and brand-new furniture popping up in his pad.
Coincidence? Perhaps not.
Consider that if your child is asking you for money, it may be a sign that he doesn’t have the firmest grasp on his finances to begin with. So if you’re not completely sure where those dollars are going, think about placing parameters on how you fork over the funds.
For starters, consider paying the lender directly, suggests ReKeithen Miller, CFP®, with Palisades Hudson Financial Group who is based in Atlanta. “That way, the child can’t divert the funds for other purposes,” he says.
You could choose to disperse the loan in smaller amounts over time to help ensure that your child isn’t tempted to splurge with such a large amount, Miller adds. This also provides the option to refuse to release further funds if your child isn’t using them for their intended purpose.
Finally, if you feel your child needs to learn a serious money lesson, you can require that they get smarter about money management before you fork over any cash. “Parents have the option of making the loan conditional,” Miller says. “For example, if a child has issues with budgeting or credit card debt, you can require them to enroll in credit counseling before you agree to lend them the money.”
“There have to be consequences, such as interest and fees for late payments, just like with a ‘real’ loan.”
- Set Terms for Late Payments
Your child likely has every intention of paying you back — but you can’t deposit good intentions in your bank account. To help keep your child accountable, lay out what happens if she is unable to pay you back in a timely manner.
“Treat [the situation] as if you were the bank giving the loan,” King says. “There have to be consequences, such as interest and fees for late payments and defaults, just like with a ‘real’ loan.”
There’s another potential benefit to charging interest: The IRS may be less likely to view your loan as a gift, says Miller, which means it won’t count toward your annual gift-tax exclusion amount. He suggests choosing an interest rate in line with the Applicable Federal Rate (AFR), an interest rate calculated by the IRS each month. Remember to consult with your tax advisor to be clear on how you report the interest to the IRS.
It’s also important to consider baking in how the payment terms might be adjusted if your family member’s financial circumstances change, either because of job loss or another income hardship. Could you, for example, reduce the payment amount temporarily, but raise the interest rate? Give them quarterly rather than monthly deadlines? Reduce the amount they’ll eventually inherit by the amount of the loan?
It may seem awkward at first, but not agreeing on those types of details up front only stands to heighten the tension later. King recalls one story about a colleague whose mother-in-law loaned her a few thousand dollars to buy a new car. They settled on a monthly repayment amount, but the colleague lost her job and was unable to make the payments. Even after finding a new job, the colleague was making much less and still couldn’t afford to the payments.
“She felt as if she were being judged by every purchase she made. She got the feeling that the mother-in-law was saying, ‘If you can afford that, you can pay me what you owe,’ ” King says. “And every time [her husband] sees his mom, he’s always waiting for her to bring it up — not knowing what to say if she does.”
- Present a Unified Front
That good-cop, bad-cop dynamic can have much bigger consequences when you’re talking money. So before saying yes to a loan, make sure you and your spouse have agreed upon all of the loan terms. This will not only help avoid an argument later, but could also help protect one spouse in the unfortunate event that the other isn’t around to enforce the agreement.
“A common scenario I’ve seen is where Dad discusses the terms of the loan with the child without involving Mom. Dad dies without communicating the loan terms, and Mom is in a situation where she has to decide if her child is telling the truth — or trying to shirk responsibilities,” Miller says. Plus, “If Mom forgives one child’s debt, she may be obligated to do the same for the other children to avoid tension within the family — and she may not be in a financial position to do so.”
One other piece of advice? Consider getting input from a financial advisor, who may be able to help you and your spouse settle disagreements on loan terms, as well as help play bad cop to the kids, if necessary. “Inserting a third party into the mix may make the children more apt to abide by the terms of the agreement, since they know someone outside of the family is monitoring the situation,” Miller says.
- Get *Everything* in Writing
As with any other bank, the Bank of Mom and Dad should have a promissory note signed by both parties that lays out all of the loan terms, including the principal amount, the interest rate, the payment structure, and any other conditions you’re expecting your child to meet in order to be “approved” for the loan.
“Even though the money transaction is between family, it is best if it is treated like a business transaction. Be as clear as possible on the expectations, and it will cut down on family disputes down the road,” Till says. “[And] it’s important to stay firm to the agreement. This can be a learning opportunity for your adult child — no matter the age.”