Loaning money to family members is always a slippery slope. Before you write the check, make sure both sides are clear about how your hard-earned money is to be used and on what terms.
- When it comes to loaning money to a younger family member, make sure you and the recipient are clear about the terms of the loan and expected repayment obligations.
- When approached for a loan from a younger family member, it’s essential to understand if the money is to be used to fulfill a need or a want.
- A “family bank” loan can fulfill a younger person’s needs while teaching fiscal responsibility.
A distressed single mom called me the other day because her daughter was in a crisis. The daughter couldn’t afford to pay a $300 car repair bill, and beyond that, probably needed a new car, which was going to cost a lot of money. Of course, the mom wanted to help just like she always does when one of her three kids or grandchildren needs a lifeline. But, every time she gives, the funds tend to disappear without any accountability for how or when they were used.
Does any of this sound familiar?
If so, when it comes to lending money to family members, you’ve got three approaches:
- You can just give your money outright–“Hey, do whatever you want with it.”
- You can loan the money with the expectation of it coming back to you.
- You can go the “Tough Love” route—i.e. do nothing.
Needs versus wants
At one end of the spectrum there are real needs here: Bills have to be paid or a loved one’s going to be thrown out of their house. There are health issues, safety issues, things that are really important and potentially life threatening. Most Boomers are glad to help with those kinds of real needs. On the other end of the spectrum, you have “wants.” For example, you send money to help a loved one to fulfill a real need and then find out they took the cash to finance a trip to Europe. Pretty disturbing.
You don’t want to damage family relationships by calling them out for irresponsible decisions about money—irresponsible at least by your standards. But remember, the young people in your life laid the tracks of their relationship with money when they were very young. And they built those tracks up over time. So now you’re at a point at which you need to decide if your money should be distributed down the line to a young relative who has needs (and wants) to be fulfilled.
Enter the family bank
Loans between family members can cause a host of raw emotions to surface. But, there’s a strategy I recommend called the “Family Bank.” Rather than simply gifting the money, you loan the money out for down payments, or even for entire purchases of homes, cars, or any other large ticket item with the understanding that the funds are to be paid back over time, at a reasonable, fair market rate of interest. The loan could be interest-only for 30 years, and the rates, according to the government tables, are very low right now–in the 3-percent range.
Why is this important? Well, the money stays in the family. The children, nieces and nephews are paying interest back to parents, uncles or aunts, and giving them the equivalent of bond rate of return. That’s an OK return for the “family banker” and the money is staying within the family. So it’s taking care of homes, cars, or other large ticket purchases that young people need to move on with their grown up lives. It’s a smart estate planning tool and it preserves family relationships.
Drawing a line between needs, wants and tough love is never easy. But having a family bank or other family-money policy in place makes it a lot easier on all concerned. When financial and non-financial real-life gets pushed together that’s where you get money’ affecting life decisions and life decisions affecting money decisions. If you or someone you know is in a situation like this, please give us a call. No two situations are alike and we’ll help you think it through. So, until next time, enjoy. Gary
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