“The children get a loan that might have cost them thousands of dollars of fees with a traditional lender, and the parents get an income stream that gives a better return than a savings account would.”
Many seniors are lending money to their adult children. The kids get a loan that might have cost them thousands of dollars of fees with a traditional lender, and the parents get an income stream that gives a better return than a savings account would. At least – that happens when everything goes as planned. If you are thinking about making a significant loan for your child to buy a house or car, you need to evaluate this question – should you play banker for your adult children?
Reasons That Parents Make Loans to Their Adult Children
Besides the obvious motive of wanting to help their children, many parents want to make their liquid assets work harder for them. Let’s say you liquidate a significant portion of your investments out of concern about the stock market. In the past, you could dump that money into a savings account that would earn interest and be safer than the stock market.
The problem now is that savings accounts have extremely low yields. The average savings account currently pays only 0.06 percent interest per year. Many of the big, national banks pay only 0.01 percent. Making a loan to your child with an interest rate of 2.5 or 3 percent, can help the parents keep up with inflation. A savings account with a balance of $100,000 and a 0.01 percent yield will generate only $10 a year in interest. Lending your child the same $100,000 at 2.5 percent will get you $2,500 a year in interest.
How to Take the Idea for a Test Drive
Understandably, many parents worry about making a large loan to an adult child. Not to worry – you can make a loan for the down-payment instead of the entire mortgage. You risk a smaller amount, and both you and your child can discover if this arrangement works for all of you.
Depending on the mortgage and the total down-payment, the down-payment loan can help your child qualify for the mortgage and not have to pay for Personal Mortgage Insurance (PMI). PMI can add $100 or more to your child’s monthly mortgage payment.
Downsides of Parent “Bankers”
It could be devastating to you financially, if your child does not make the loan payments. This situation could cause you to have to work for many extra years or not be able to retire. You could find yourself in poverty when you retire. Only lend money that you can afford to lose.
You need to consider how lending a substantial sum of money will affect the money your other children inherit. Make sure that you work with your estate planner to protect your estate’s right to the money. Finally, consider how the loan will affect your relationship with your child and your other children. The Thanksgiving meal can be awkward, when family members borrow money from each other.
Tax Issues of Lending Money to Your Children
You must create the proper documents, like a mortgage or promissory note, to keep the IRS from treating the loan as a gift and imposing a steep gift tax. It is necessary to charge at least the rate of interest that the IRS requires. These rates change every month, so you will need to check and re-check. You will also have to register the mortgage with an approved company for your children to take the mortgage interest deduction.
Your local elder law attorney can help you prepare the documents you will need to memorialize the loan and help you strategize how to make the loan work with your estate plan. An elder law attorney in your area can explain how your state’s laws might differ from the general law of this article.
CNN. “Savings accounts with the highest yields.” (accessed January 17, 2019) https://money.cnn.com/2013/10/01/pf/savings-account-yields/index.html
AARP. “Should You Give Your Kids a Mortgage?” (accessed January 16, 2018) https://www.aarp.org/money/credit-loans-debt/info-08-2013/giving-your-kids-a-mortgage.html