People regularly ask me whether they should lend money to their adult kids, and in most cases my advice is simple… don’t.
That may sound harsh, but it’s actually well intentioned. I’ve seen too many close friends lose big chunks of their savings when they act as a family bank and things go wrong.
And it’s not just the finances that can suffer, either. Relationships can quickly sour and families can be torn apart by money, too.
But despite these thoughts, there’s no denying that intra-family lending is something that happens all the time. We are parents after all and we want to do the best we can for our adult kids… but you really need to understand the risks.
Here are my tips to make sure you’re protected when offering financial assistance.
1. Giving them a loan
If you’re playing the role of a bank, don’t be afraid to act like one.
Treat the loan as a business transaction and draw up a formal agreement between each party outlining the terms of the deal, including a set repayment schedule.
Using a lawyer to draft this helps to avoid potential pitfalls and signals that you’re serious. If your child’s relationship end, it can also help to ensure the money stays in the family.
At the end of the day the most important thing to do is communicate. If a payment is late, deal with it straight away and don’t let things fester or become awkward.
2. Gifting them money
Some parents may be in a position to gift money to their adult kids. While gifts are great in that they’re generally tax-free, if tax has already been paid on the money, there are pitfalls to be aware of.
For example, if your child is married or in a de facto relationship and it ends, gifts will usually be considered part of the family assets and divided up in court.
On the other hand, formal loans as described above are legal liabilities for your child, which will ensure that your gift doesn’t leave the family unintentionally.
3. Acting as a guarantor
Becoming a guarantor sounds like a simple proposition.
Fill out a couple of forms, sign on the dotted line and think happy thoughts about how you’re helping your child get a loan and realise their dreams.
But if things go wrong and your child defaults, that fuzzy feeling can quickly translate into cold hard cash. So it’s important to stop and think hard about what would happen if things go wrong.
In many cases it’s possible (and prudent) to limit your liability to a fixed amount that you can realistically afford to repay. An unlimited guarantee means you can have unlimited risk.
4. Repaying or taking on debts
It’s heart wrenching as a parent to watch your kids go through a tough financial situation.
But with our kids, we strongly believe they’re big enough to fend for themselves. They’re old enough to deal with the consequences of their own actions… and learn from them.
Rather than just stumping up to dig them out of a hole, a better idea might be to offer to help them do it themselves.
Sit down and teach them about budgeting and debt consolidation. Or maybe offer to fund a visit to a financial adviser.
The lessons learnt will stick with them for life and be far more valuable than money.
5. Helping them start a business
If you’ve raised a family of budding entrepreneurs, it’s highly likely that at some stage your children will ask you to invest in their new business.
Now, we’ve been involved in small business for decades and think entrepreneurship is something to strongly encourage… sensibly.
Think of your role as that of a regular investor.
Ask to see a business plan, and feel free to make suggestions or call out areas for improvement. And be clear about what this money entitles you to when the business takes off.
And don’t front up the entire amount either. If they haven’t got any money, tell them to save and come back when they do. Or give them a small amount of what their asking for with the promise you’ll add to it if the business passes specific milestones.
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