Broker Check

Give & Take - Set Rules When Loaning to Adult Kids

by Howard Hook, CFP®, CPA

As published in the New York Daily News "Money Pros" column, February 11, 2014

Question: Times are hard and my adult child wants to borrow money from me. Should I do it, and if so, what should I do to make sure this arrangement works out well?

Answer: Making emotional money decisions rarely turn out well. As human beings our brains are wired to make decisions that make us feel good, rather than those that may be correct but don’t make us feel so good. Giving money to an adult child is a prime example of this, unless you are prepared to take a few steps prior to giving the money.

The first step, and arguably the most difficult for a parent, is to decide if you can afford it. If it will cause a hardship now or in the future, you can’t be afraid to say no. Too many times, parents are not truthful to either themselves or their children, which can result in hard feelings on both sides.

In determining whether to give the money, you should presume the worst case scenario - that it will never be repaid - and what affect that will have on your financial situation. 

The ability of your child to repay the money needs to be taken into consideration. If it is unlikely the child will be able to do this, then you should recognize the transaction as a gift. This means that you’re both prepared for the eventuality of default and squaring this gift with your other children. This will reduce the likelihood of hard feelings on anyone’s part.

Should a decision be made that giving the money is a loan, than the terms - the interest rate charged, and the repayment period, including what happens if the loan is not repaid - must be spelled out in writing. This helps prevent any misunderstandings that may occur between the parties and puts some “realness” to the loan for both parents and child.

As a parent, you should set realistic repayment terms and charge interest at rates that will not run afoul of IRS allowable rates. Otherwise, imputed interest and income tax may occur.

Finally, parents should not pass judgment on the reason for the loan, unless of course there is some evidence the loan proceeds will be used for nefarious reasons.

The bottom line is that parents and child should want to keep as much emotion out of the process as possible.