Lending money to (adult) kids can be a tough call for a lot of parents, especially for ones that have recent graduates in today's tough job market who usually need some help.
Whether it's helping with a down payment or just a bridge loan until they start their job, it's a fine line between helping them grow up and creating unnecessary pain.
Frank doesn't have all the parenting answers, but we can help with this.
1. "It's a loan, not a gift" is a good lesson.
Some of the advice you'll get online is (surprisingly) decent. For instance, you should make sure you can afford to help your kids first. (But like everything internet related, a lot of it is off base.)
One piece of good internet advice is to make sure you set it up as a loan, otherwise it'll become a gift. This is strong advice.
Aligning expectations so that your kids understand that it's a loan and not a gift can be a powerful way of to teach them valuable life lessons, without subjecting them to the predatory actors within the financial system.
+1 to the internet on that one.
2. A family loan is different so don't pretend it's not.
This is where the internet advice goes a little haywire. Many tell you to set terms and sign a contract. There's even a company that will draft the contract and put a lien again your kids' house for you. For a $750 fee. Seriously. We couldn't even make that up.
As we showed in our 4 Myths About Lending Money to Friends and Family., that contract/lien is not only pretty useless, it's a great way to tell your kids you don't trust them.
Furthermore, researchers at the University of Illinois and Ohio State showed cooperative behavior (e.g., paying it back) amongst family members can be lower than with friends, because people know their family probably won't disown them if they don't pay it back. So your kids intrinsically understand that the contract's probably a bluff.
Let's just be frank (yes, we like puns): a loan from a family member is not the same thing a loan from a bank.
It's just not. As much as you try to make it that, it's just not. There is a lot of research backing this up.
So what's the answer? How can you can you get the 'loan not gift' advantages without ignoring the fact that a family loan is different?
At Frank we realized the trick is structure not formalities. After all, your trying to give them a life lesson, not reduce default rates like a bank is.
3. Life lessons come from structure not formalities
What's are the important lessons for your kids? Here's a few:
- Don't buy things you can't afford. So when you borrow money, you need to pay it back eventually. Money isn't free.
- Time value of money. Not only does money not grow on trees, in fact, borrowing money costs money.
- Reliable matters. When you borrow you need to pay it back every time. You can't pay one week and not pay it back the next.
Do you really need the formality of an actual loan to teach these lessons? Probably not. You just need the strucutre a loan provides.
And it's much easier to create structure in a way that's respects the fact that a family loan is different than it is to force the family relationship into a pre-defined legal relationship.
4. So what's the structure?
How do you pull this off? Frank can help you set it up properly.
- Kids decide a repayment schedule: When they want to borrow money they should know they have to pay it back. With Frank we require kids to select the repayment schedule they want to use before they take the money out. They get to decide the schedule to make sure it's comfortable, but there needs to be a schedule. And Frank makes them set that. It's an effective was of letting them know as they're borrowing the money, that if they spend it they're going to need to pay it back.
- Voluntary interest rates: We ask the kids to pay a voluntary interest rate and we show them what others pay. This idea isn't to gouge them or make money off our kids, so Frank lets them decide their own rate based off what others do. The point is to make sure they see that money costs money.
- Regular repayments: When they set their repayment schedule they attached their bank account and the repayments get withdrawn automatically. Not only does it make it easy, but it make sure you kids understand reliability. Because the reliability is going to happen automatically without the parents needing to intervene every time:)
5. Don't be a fake hardass.
The last question we always get is what happens if they don't pay it back. This is where Frank gets really helpful.
It's probably the wrong impulse it to say or pretend they're in big trouble.
Maybe you'll really damage your relationship with your kids by following through or maybe they'll just call your bluff if they guess won't disown them. This is why the Bank of Mom and Dad can be so hard.
With Frank, Frank can play the intermediary so you don't have to do it. We periodically remind kids that they still need to pay so parents don't have to be the jerk. We can even try to pull out the repayments again.
But we need to be realistic so we also make it easy for parents to delay or forgive the loan if you want to. After all, the point is to help your kids out, not just make you the predatory financial institutions.
Frank: Powering the Bank of Mom and Dad
Running the BM&D can be a tricky situation. But it can also be incredibly wonderful way to support your kids while helping them grow.