By Joel Dansby* on Dec 8, 2020
What to do when Your Adult Child Comes Looking for a Loan
It’s an unfortunate sign of the times as an increasing number of adult children, caught in the convergence of a sluggish economy, a slow job market, and tight lending, are turning to the Bank of Mom and Dad for financial help. And, as much as parents would do anything in their power to help their children in a time of need, most dread the day their child approaches them for a loan. For many, it can be a sign of failure – having raised their child without instilling the value of fiscal responsibility. For others, it comes down to affordability – can they afford to part with a sum of money even if it is only temporary.
In the end, parents are naturally prone to helping their child in need to whatever extent they can. However, before writing the check, or, perhaps, in anticipation of a loan request, they should think things through, and, if they decide to make the loan, have a detailed plan to put in front of their child. While that may seem a little harsh on family ties, it can prevent a lot of problems and heartache down the road. When that moment arises, parents need to detach themselves from their emotions and get down to the business of being the Bank of Mom and Dad.
Should You Make the Loan?
Parents need to get past the emotions of pity, guilt, or even love in order to make a rational determination as to whether or not loaning their child money is a good idea. Does the loan have a personal or business purpose with the potential of improving their lot in life? Or, will it only enable them to continue down a path of fiscal recklessness? Will their child really have the capacity to repay the loan, or should they expect to never see the money again? Whatever questions they have should be considered with their child in a frank discussion that leads to a clear understanding of the gravity of the situation.
Can You Afford to Make the Loan?
Parents, who are well off, sitting on a large cash reserve or discretionary assets, may be in a position to make the loan without adversely affecting their financial security. But an increasing number of parents of adult children are facing a potential squeeze between lower returns on their retirement savings and an ever-expanding life expectancy. Cash reserves play a more critical role for retirees who must plan for contingencies and unexpected expenses. For many, a $50,000 loan could be the difference between being able to meet their lifestyle needs and having to tap their retirement assets, if not now, then some time in the future.
Put it Writing
On the surface, formalizing a loan arrangement between parents and their children might seem a little over the top to some; however, it is important to formalize the arrangement so your child realizes this is more than a personal obligation; it’s a business obligation. In addition, a formal loan agreement can provide an emotional buffer for all parties should any problems arise.
Clear it with Your Financial Advisors
When making a loan to a child, there can be financial consequences. We’ve already discussed the affordability issue; however, it would be important to have your financial advisor recalibrate your cash flow projections to see how it might affect your future income. Second, you should seek guidance from your accountant so you understand the tax implications of the loan.
Have a Plan for a Default
No parent wants to think that there child could be a deadbeat; but life happens. Your plan should anticipate the possibility of missed payments or outright default. While it may be difficult to play banker when your children are in financial distress, they should be aware of the financial consequences when they fail to fulfill their obligation. A significant default could impact your ability to help other children with a loan; and it should be a factor in determining the amount you plan to bequeath from your estate among all of the children.
No parent wants to turn their child away; however, loaning money creates a whole new layer of obligations and implications for both the parents and their child. Parents must first consider the wisdom in making the loan – will it actually help or hinder the child’s ability to gain in life; and then consider their ability to afford the loan, especially if there is any chance of a default. Being the Bank of Mom or Dad should be serious business, requiring a business-like approach to protect everyone involved.
*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets. This material was developed and produced by Advisor Websites to provide information on a topic that may be of interest. Copyright 2020 Advisor Websites.