When faced with the decision of whether to loan money to adult children, parents are often unsure about the proper approach to take. They want to support their children, yet do not want to become enablers. A key to successfully loaning money to adult children is to have a strategic plan in place to help ensure that children are able to address a temporary cash crunch while developing productive money management skills in the process. Below are the ten golden rules of loaning money to adult children.
1) Do not loan money that you do not have.
Loaning money that you do not have can be detrimental in many ways. In addition to worsening your personal financial situation, you set an example for your child that it is okay to borrow money that you may not be able to repay.
2) Clarify the purpose of the loan in advance.
As a parent extending a loan to your child, it’s important to ask how the money you lend will be used. You have the right to refuse your child’s loan request if you feel that the request is unreasonable or if you feel that the funds will be used inappropriately. Be sure to differentiate between a loan and a gift. A loan is expected to be paid back, whereas a gift is given with no strings attached.
3) Create a written “contract” that specifies the terms of the loan.
Making a loan as businesslike as possible increases the chances of a positive result. Prepare a draft that outlines the details below and sign a copy together with your child:
- The loan amount
- The purpose of the loan
- Terms of the loan (when the full amount is due)
- The total amount to be repaid, including interest
- Any special incentives for early repayment or additional payments
4) Offer an incentive for making additional payments or paying off the loan early.
As a parent, you have the ability to reward your children for paying their loans off as quickly as possible. An example of an incentive could include reduced interest charges.
5) Establish boundaries.
You can love your children unconditionally while also setting boundaries. Be empathic but firm as you talk to your children about the pros and cons of borrowing money. Make sure adult children know that you reserve the right to refuse any future loans if they ignore or fail to abide by the terms that you both agreed upon in your contract.
6) Outline terms for late payments.
Most established lenders and credit card companies charge late fees if customers fail to make loan payments on time. Parents can stress the importance of repaying loans on time by charging penalties or fees for late payments.
7) Get to the heart of the matter.
In some cases, there might be a greater underlying problem contributing to your children’s cash flow troubles. If requests for loans occur with increasing frequency, it is a good idea to sit down with your children and review their income, expenses, and spending habits.
8) Ask your children what plans they have in place to improve their financial situation.
Loaning your children money may provide a short-term solution to a financial squeeze. However, a loan will not help them create a plan to avoid the need for future loans.
9) Require your children to enroll in credit counseling before you agree to lend them additional money if the request for a loan becomes a continuous habit.
Credit counseling helps people develop money management skills. Additionally, this measure helps to foster a sense of accountability that might be lacking in adult children.
10) Consider making payments on behalf of your children instead of handing them the money.
This strategy helps prevent your children from misusing the money you give them on unintended expenses like vacations or other items not outlined in the original loan request.
The guidelines above combine to form a comprehensive strategy for parents facing the prospect of loaning money to their adult children. By following these suggestions, parents can bolster the odds that their children will improve their money management skills.