Getting a loan has become a lot harder, thanks to the crisis rocking the credit markets. The tightening of the lending market could have a big impact on the people in your life who don't have much cash or credit history -- people like your kids. If your adult child wants to buy a house, start a business or just scrape together money to pay the bills, borrowing from mom and dad may be one of his or her only options.
Lending to children can be tricky, however. You don't want money to poison your relationship with your child -- and you definitely don't want to support bad habits. Before handing over a check to your son or daughter, think carefully about whether a loan is the best solution. If it is, consider how you want to set the terms of the payout.
Your first step: Weigh the merits of the request. If your child could forego the loan by making a sacrifice -- taking the bus instead of getting a new car, say -- encourage him or her to do so.
If your child has been financially irresponsible in the past, be realistic about the chance you'll get paid back. That said, it's also worth considering the possibility that your loan will help your kid straighten things out -- for example, by helping eliminate credit card debt or other financial baggage.
You also need to make sure granting a loan won't stretch your own financial resources. After all, your dependents will all be worse off if their lifeline begins to sink. Discuss the decision with your spouse and possibly your financial advisor, and take into account how you would be affected if your child failed to repay the loan.
If you're having doubts, consider other options. You could co-sign a bank loan for your child, but keep in mind that your credit rating would be on the line. You might investigate alternative means of getting loans, such as social-lending Web sites. You also can get help arranging your intra-family loan from a third party. For example, Virgin Money offers a service that manages loans between family members.
If you do decide to grant a loan, make your terms clear. Family financial conflicts often begin because parents fail to communicate that they are making a loan -- not a gift. If you expect to be paid back, explain so kindly but unequivocally. And do so before you hand over the funds.
Make sure you and your child agree on how and when you will be paid back. A fair repayment schedule will vary depending on your situation, but it's important to lay out a concrete plan that realistically meets both of your needs.
That plan could include interest. You'd be earning interest if you left the money in the bank, so it's fair to ask your child to make up that lost income. Even if you charge only a minuscule rate, requiring interest will send a clear message to your child that you take the loan seriously. You might charge the same rate the money would be earning if it were in a savings account. Alternatively, you could charge the rate a bank would levy for a similar loan. The current prime rate is a good guideline.
It might make sense to set other conditions for the loan as well. If the child says the loan is to pay for a certain expense, you may want to see proof that it's been used that way. If appropriate, ask the child to consult with a credit counselor or a financial advisor, and consider helping out with the cost.
And don't forget to put all of this in writing -- one copy for you and one for your child. Have both parties sign the document to make it official. Handling the loan as seriously as you would any other financial transaction can help you assist your child without risking your relationship.