We have all heard the warning, and probably dolled it out ourselves: Don't lend money to family or friends. But it can be hard to turn down family members in need of a cash infusion.
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Ameriprise Financial released a study last year showing 93% of surveyed boomers have provided some form of financial support to their adult children. What’s more, 71% said they have helped them pay for college tuition or loans, and 55% have allowed grown children to move back home rent free.
But helping out a family member can bring havoc on boomers’ finances and retirement funds, especially since wages remain stagnate as the cost of living and health-care cost rise. Getting squeezed by the touch economic climate and cash-strapped family members can put a dent in any boomers’ nest egg, which is financial experts say if parents are going to lend money they need to set clear guidelines, expectations and lending terms.
Scott and Bethany Palmer, financial advisors and co-authors of The 5 Money Personalities, offered the following tips for boomers dealing with adult children needing financial help:
Boomer: How should baby boomers handle adult children’s requests for a loan/money? How can they make sure they are making responsible loans and keep relationships intact?
Palmer: Tension is inherent in relationships with adult children and their parents, but money issues just bump it to the next level. Because adult children are asserting themselves and enjoying newfound independence, they don't typically want to consult with their parents about major decisions. But they're not completely financially independent, either. It makes for a sticky situation.
Unspoken or unclear communication about money between the two parties make the situation even worse, because we all hear what we want to hear. For example, we wonder how often claims like these have taken place: "That was a loan? I'm your kid. I thought it was a gift” or “I didn't know there was a time limit on when I paid you back!"
If you plan to assist your adult child with financial support, be sure to put it in writing—but try to avoid calling it a contract, as that might create feelings of negativity or foster mistrust. Instead, call it a Letter of Understanding that puts the agreement in writing so both parties understand the expectations. It doesn't have to be a formal contract, but a Letter of Understanding serves the same purpose and settles the potentially difficult-to-navigate relationship side of it.
This piece of paper shows you value your relationship and want to preserve it. It's not that you don't trust them; you just understand that time will pass and memories get foggy.
Boomer: How do we say no if we can’t afford to give a loan or don’t think it’s a good idea without alienating or causing tension? How do we evaluate the risks of making a loan?
Palmer: We don’t sound the debt alarm very often, but when it comes to young adult children asking their parents for help with debt, well, the alarm bells start ringing!
These days, even 19-year-olds can be riddled with debt. Student loans, car loans, credit card debt can add up quickly, leaving young people buried in debt before they’ve even cashed their first paychecks. Sadly, debt follows young people for a long time.
As parents, you have to make some tough decisions about how much help to give a child in debt. Before you write a check, ask yourselves these questions:
Where did this debt come from? Is your child spending money on clothes, Starbucks, and nights out with friends, or is the debt the result of something less predictable like medical expenses, a change in her housing situation, the loss of a job, an added class? If your child has ended up in debt because of unforeseen circumstances and you’re able to help, do it. If the debt is the result of careless spending, this would be a great time to hold back and help teach living on a budget.
Have we bailed our child out before? Every young adult will run into money problems sooner or later-it’s part of growing up. But if your child has chronic money problems and can’t seem to work them out, it’s time for you to seriously consider how much longer you will provide financial help. If this is a pattern, your child needs a financial education, not a handout.
How can we help our child think differently about spending, saving, and debt? If you don’t know your child’s money personality, now’s the time to figure it out. For children that are “spenders” help them understand their natural propensity towards debt and work out a plan to help them live with their means. “Risk takerers” need to know how saving more now can lead to smarter investments later.
When should reality hit? If your child’s spending is out of control, it might be tempting to cut off financial aid, but not every young adult is ready for total financial independence. Most will need to take on a little bit of responsibility at a time. Start your child on the road to independence by going over credit card statements and detailing how these companies make money and how much the interest really costs. By showing how to prioritize spending and even make a budget can help set lifelong financial rules. And be transparent: If you have had challenges with debt, share your experience.
How can we use this conversation to strengthen our relationship with our child? Your attitude will speak volumes to your child. Make sure you stay calm as you talk about your child’s debt. If you decide provide funds, explain your decision and what you expect in return. If you say no, explain that decision as well and offer your help in working out a plan for paying off the debt. Make sure you and your partner are both involved in these conversations–a united front tells your child that you care and are working together as a family to find a way forward.
Young adults are returning home at an increasing rate. But that doesn’t mean they have to return to financial dependence. Helping your child manage her debt-either by paying it off yourself or showing her how to pay it down-will be one of the best life-skills you can give her.
Boomer: What is the best way to determine payback options and expectations?
Palmer: As mentioned above – be sure to include your children in this expectation discussion of the payment details. Make sure that they "buy in" to the deal and agree to the terms in writing. If at any point you receive "attitude" about this discussion – then say "NO" to the loan.
The five components of the loan payback are as follows:
1. Loan amount: Round off the amount to a whole number
2. Waiting period: the length of time before the payback starts. We don’t suggest making this time period longer than three months
3. Length of loan: one to five years (we wouldn’t suggest longer than five years)
4. Payment options: monthly, quarterly – (we don’t suggest any longer then quarterly)
5. Interest: Even if it is 1% we strongly suggest adding interest – this teaches them that loans have financial consequences.
We suggest keeping an excel spreadsheet to document the payment and date. Nothing worse than the "Oh I thought I paid all of that back" conversation