I had a conversation recently with a retiree who was approached by their child for a loan to start a business. Lending money to children can be a messy business if not done properly. As a new parent, I can understand the drive to want to help your children in every way possible, but as an advisor there are important factors to consider for all loans to children. I outlined 4 points to my client, which I’ve listed for you here below:
- Don’t compromise your lifestyle. If lending money is going to mean that you have to reduce your standard of living in order to make this loan, it should be a no-brainer to hold off. Yet, I’ve seen circumstances where retirees even go back to work because the loans that were made have decreased their income substantially. If lending the money is going to cause a huge strain on your finances, you’ve got to say no.
- It’s ok to lend to one child, and not another. This isn’t about playing favorites as a parent, which I know you would never do. It is about knowing your children and understanding their financial personalities and their ability to repay the loan that you’re making to them. Some are more credit-worthy than others and there’s no reason that shouldn’t play a factor in your decision. Lending your financially-responsible child money for a down-payment on their home is one thing, lending your more creative child money to take a spiritual trip around the world is another.
- Get it in writing. Just because it’s a loan between family members, doesn’t mean that you don’t need to take care of the legalities. In fact, it’s all the more reason to make sure both sides are protected. What is the interest rate that they will pay on the money? When are payments due? What happens if they can’t make payments? Better to discuss these factors in advance rather than assume you’ll be able to deal with them if something happens. It’s much easier to talk about these questions before trouble arises so be courageous and have the conversation. Get all parties to sign on the dotted line, and stick to the terms.
- Consider equalizing your estate. If you pass away before the loan is repaid, consider having your executor equalize the estate with other assets. This still relieves the child of the obligation to repay your estate, as well as setting up a mechanism for your other children to not feel like they received less money from you because of the loan that was made to their sibling.
These four points can be the starting point of a healthy discussion about lending money for you and your child. Are there any other items you’d add to my list? Please add them in the comments below!