Making a Loan to an Adult Child

November 2, 2012
The decision to lend money is difficult under the best of circumstances. But when the request comes from your adult child, the situation becomes even more fraught with emotion and anxiety.

In a perfect world, your son or daughter would never need to come to you and ask for a loan. But life is never perfect and given the current state of the economy, more and more young adults are finding it very hard to manage on their own. Unemployment rates have skyrocketed over the past 6 years and a large percentage includes people in their late teens (23%) and early 20s (13%). One of the largest segments of the U.S. population not to have health care coverage is young people between the ages of 18 and 34. When you add in the rising cost of higher education and a sluggish job market facing new college graduates, the outlook is anything but rosy.

If you are now faced with the decision whether to lend your child money, financial experts advise that you consider the following suggestions before making a definite commitment.

  1. Be aware of the reason the money is needed. You have every right to know what the loan will be used for. Ask if your child has tried to find extra work (income) and reduced expenses as much as possible. Many financial planners recommend only lending money for truly necessary reasons, such as paying rent, buying food or covering bills. High-end purchases do not qualify.
  2. Keep the loan process professional and business-like. Experts agree that any type of loan should be treated as a legitimate business transaction. This means having a written contract which includes all the terms and conditions of the loan (such as interest charged) and a firm repayment schedule. Both the parent(s) and the child would sign the contract.
  3. Charge a reasonable interest rate. The prevailing wisdom is that 5% is a very reasonable amount to charge your adult child for a loan. You may have difficulty rationalizing this, but research seems to indicate that your child will benefit from this in the long and will learn a valuable lesson.
  4. Don't put your financial well-being at risk. If you are concerned that lending your child money will compromise your current lifestyle or will force you to take funds from your retirement accounts, you really should hold off making the loan. It's tough, but if giving your child money is going to cause a huge financial strain, you really have to say "no".
  5. Be firm about the repayment schedule. If your son or daughter misses a loan payment(s), you need to have a serious talk and review the budget. Don't let your adult child treat the loan as a "gift". Get tough and remind him or her that you both agreed to a legally binding loan contract and you expect it to be honored and repaid responsibly.