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Is Lending Money To Your Children A Good Idea?

September 25, 2012 1:51 pm
posted by James Parnwell

Lending MoneyIn the currently difficult economic environment qualifying for a loan can be tough, it is no wonder that more and more parents are only too willing to offer their children a helping hand when it comes to buying a house or consolidating debts.

We have been seeing more and more parent lending money to their children to help with home loan deposits or doing something even more serious – offering their own home as added security in the purchase of their children’s home.

Lending Money to Your Children

According to a recent survey, 20% of parents have already lend their children money or offered them a gift of home deposit, or co-signed a loan to help their children purchase a home.

A further 66% of parents indicated that they would like to do so in the future.

But is lending money to your children really a good thing?

Why not you might say?  You have paid for their school and many other expenses when they were small, why not offer a helping hand now?

While making a difference in your children’s life can be a very rewarding feeling, all too often both sides come out losing money. This sometimes leads to the family relationship being damaged beyond repair.

Why lend?

For families where children feel that they can lean on mum and dad whenever they need something rather than pursue avenues that might require more initiative and accountability – this is yet another example of “helicopter parenting”.

If you know that you can ask for an receive an interest free loan or a gift from mum and dad, then isn’t that a better, easier way to go than a financial institution which actually expects to be repaid, on time, with interest, per your agreement?

This is nothing more than allowing your children an extension on time without adult responsibilities and a need to grow up and look after themselves.

Adult children who are given frequent loans from their parents are often much less successful than those who are forced to make it on their own and this entitlement from their parents may expand into ultimately tapping into governmental resources to support themselves.

Family loans create a generation of financially dependent children. Whereas you may have had to help your parents financially, as well as support your adult children, will they be able to do the same for you in your old age? Probably not.

Alternatively if your child is unable to qualify for a loan with a bank because of bad credit or poor repayment history or simply inadequate or unstable income – your decision to lend them money is risky.  If lenders who specialise in assessing credit risk turn your child down, then shouldn’t that be a cue to you that maybe the risk is too high for you as well?.

Impact on your retirement position

Lets take an example of  a $10,000 loan to a child when the parent is 50 to be paid back in 5 years but never repaid

This loan will deprive the parent at the age of 65 of $31,722 retirement income (at an 8% return).

We have seen parent losing their family home because of loan guarantees offered to one of their children. Naturally the other children are not very pleased and this can be the start of a prolonged family feud as well as parents  losing their financial independence when they need it most – at retirement age.

All that said, there are some exceptions where family loans can work. As financial educators who regularly counsel parents on this topic, we do encounter situations where family loans are a good idea and where they end up paying off for everyone involved. Almost invariably, these situations have the following characteristics:

– child is financially independent and requires a short term loan due to unforeseen circumstances (such as ill health or new business). However this should be a separate loan rather than a guarantee against a parent’s home.

– parents are themselves financially secure, the loan is a very small percentage of their overall wealth, and they will not compromise their retirement or any other financial goals if the child fails to repay the loan.

– a formal legally loan agreement is signed and adhered to.

However as a general rule, family loans can create a lot of longstanding problems and are not a good idea.

Article by Income Protection Insurance AU

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Disclaimer:

This article is not designed to provide personal financial or investment advice. The information provided is general in nature and does not take into account your particular investment objectives, financial situation or investment needs. We recommend that you speak to your financial Adviser before you make any further decision.

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