Billy Murphy is a happy recipient of a loan from the bank of mom and dad, an amount he used to purchase his home in New York City. The 32-year-old firefighter had to come up with the house’s down payment but the piggy bank of the family; his parents came through with the rest of the amount. To make the deal just better, half the loan from his parents was passed on a gift!
His story is not unusual. Katie Larcher, on the other hand, is in her late 20s. Her friends are purchasing their own homes funded by their wealthy parents. In a time when there is a housing crisis, homeownership is becoming a tall order for most millennials. Most of them have made their best efforts at saving, but most of their income is going to rent, bills, and student loan payments. House ownership seems like a far-off dream.
Katie’s mom, Brenda decided to give her a loan to finance her first tiny flat. “Renting is such a waste of money,” Brenda explains. Katie is just another recipient of credit from the bank of mom and dad.
Another common need is a car loan, and that can be a little trickier to navigate.
The high debt problem
There has been an ongoing discussion centering on the fact that millennials cannot buy homes, becomes they are financially irresponsible. A few of them might be, but the most significant percentages of young people are actually not getting married, having children, owning cars or homes because they cannot afford to. So yes, the problem is not the expensive coffees and avocado toast either, nope, they are paying off massive student loans. In the U.S, there are over 45 million educational loan debtors, who owe over $1.2 trillion, each with an average debt of $30,000.
This is why the venerable bank of mum and dad is quickly becoming the only route for most young people to quick homeownership. Statistics show that in 2011, 1/3 of all first time home buyers used a gift (26%) or a loan (75%) to purchase their homes. The amount loaned by parents or given as gifts could be higher because most gifts are hardly ever disclosed to most lenders.
The warning bells
Most financial experts advise parents against lending money to their adult children. There are a lot of negatives attached to it, including fostering dependency, inflaming family tensions and robbing the older party of their hard-earned retirement savings. These ingredients could adversely impact even the healthiest and loving of family relationships.
Loaning your children part of your retirement kitty might seem straightforward at the onset, but later mutate into a straitjacket situation, that impedes on family harmony, if the loanee fails to keep their end of the bargain. There are apparent advantages of getting a loan from parents as they are kind of pre-approved as well , which includes low interests’ rates or none at all making them a very attractive offer. But do keep in mind that the parent is placing their financial health in dire jeopardy by taking that money from their lifetime savings.
However, if a parent has to give that loan, they should rationally consider their decision. It is essential to treat the family piggy bank as more of a “bank” than a “piggy” if you are giving a loan to junior. So how do you do this?
- Call it by its name
Ensure that your adult children know that what you are giving them is a loan and not a gift. If the money is a gift, give it unconditionally. Did you know that you can give away as much as $12,000 per year without having to file returns for gift tax?
If it is not a gift, drop the casual attitude and for the sake of your relationship with your children, be very specific with your terms. Establish the parameters for the loan repayments and formalize the loaning process. Leave the boundaries loose, and you might be setting up your family for unnecessary tensions.
- Discuss the need
Family is perhaps the hardest place to talk about finances, but if you are loaning out your retirement benefits, then you have to hold that bull by its horns. Keep in mind that the loan might jeopardize your financial health. Many parents will not ask their children questions when loaning them cash, in a bid to not embarrass them.
While there are financial problems that could be private, a jumbo loan request should be tabled, and its need examined acutely. Is it for a business? Where is the business plan? Act as a bank. Let your children know that this is your life’s blood, not petty cash, and they can only borrow it if they absolutely need it.
Remind them of the consequences that you will face if they fail to keep their end of the deal. You will probably have to forego the holiday you have saved for, for decades. You might also have little left for basic needs forcing you to borrow a high-interest rate loan in your retirement.
- Document it
Money and relationships often make for a messy mix so when issuing a loan, draft a document detailing the loan’s structure. Have a promissory note complete with a repayment schedule. Ensure that the repayments are tailored to the existing interest rates since the installments paid will be taxed just as ordinary income is.
Set up an ETF arrangement to ensure that the payments are deducted from your children’s checking accounts and paid to yours. Set the tone from the very start to ensure that other family members in the future, who come to the family piggy bank, play by the rules. Talk to your other children also, when loaning one of them large amounts of money. Be upfront and ensure that you do not disadvantage them when helping out their sibling.
- Find an intermediary
If due to your relationship with your children you cannot have a formal loan agreement with them, seek the assistance of intermediaries. Intermediaries such as Virgin Money have no problem at all handling the awkward conversations. They will help you separate business from family ensuring that you are not both debt collector and loving lender.
The intermediary will see to all legalities of lending and repayments as well as tax and any legal issues. You, in turn, will stand a better chance of having your retirement funds back into your account and maintain a stable relationship with your children as well as you help them out too.
The bottom line
Evaluate the risks before lending out money and ask your children to do the same because your well being is their priority. The stakes are so high when it comes to family relationships and money given away in old age. Use the above money and debt management steps, and you will be a better problem solver for your children.