Whenever a financial issue involves a family dynamic, advisers must approach the topic with finesse, says Howard Hook, a certified financial planner (CFP) with EKS Associates in Princeton, New Jersey.

“Your answer might not be what the client wants to hear on an emotional level,” Hook tells PLANADVISER. “As much as you’d like to help your child financially, it will have a material effect on your ability to retire, which they might not want to hear.”

The ideal way is to lay out the pros and cons of lending money, and project what could happen if there is a failure to repay the loan. People should face a worst-case scenario, Hook advises, in which they might have to work longer, change their lifestyle or their goals. Those are pretty extreme cases, he says. “Most of the time, the amount of money being lent is not material,” Hook says, “perhaps $10,000 to $20,000 for a down-payment.”

But sometimes the money is more substantial, such as an amount of $100,000, or there are multiple requests for loans. Depending on the age of the child, Hook says it might be excusable. “We call that growing into a lifestyle,” he says. People in their 20s may have to stretch a little, given their lower salaries, but they are looking to buy a bigger house. When older people ask their parents for money, it could be an emotional issue.

Hook says they acknowledge that the client is doing something nice for the child, but that the loan is creating a great deal of emotional stress, and perhaps some financial stress. “At some point the children have to stand on their own and realize that this cannot continue,” Hook says.

“We tell clients that when you lend money to family members, there is a less than 50% chance they will get the money back,” Hook says, adding that the figure is an estimate and not a statistic. “If they’re really concerned, we’ll run a cash flow projection and see what it looks like without the loan repayment.”

Fiscal Responsibility

The downside can come when someone feels they’re OK without the payback, and doesn’t push as hard for repayment, creating a situation in which the child feels he can come back repeatedly for more money. Children should have some fiscal responsibility, Hook says. When they are on their feet it is a better situation all around. Questions are sometimes more easily answered when the adviser knows the family as well as the children. Sometimes it is a client’s sibling who is asking for financial assistance.

Hook encourages clients to get a written agreement for amounts above $5,000 or $10,000. Once the money is spent, it’s gone, and the written document makes it real for both sides. Hook suggests the agreement include repayment terms and even that it specify collateral, in some cases, such as selling your business to a family member.

Often there is a disconnect between what the child thinks and what the parent thinks, according to Hook. The child might assume that the parents have the money and do not need it; the parents have more questions and more uncertainty. Some turn to an adviser to ask if they can afford to lend the money. Hook says that question really means, “I’m not sure I really want to do it. Please tell me no.”

Sometimes the parents really cannot afford to lend the money. Even if they are able to, most people feel some emotional stress in this situation when they wonder what the effect will be on their ability to retire, even though making the loan would be emotionally satisfying.

Blame the Adviser

Hook suggests that people determine if the loan will create a situation with an intolerable amount of discomfort. If that is the case, he says, they can shift the decision and say their adviser has told them they cannot afford to do it. “Now you’re moving the blame elsewhere,” he says, which can ease the family situation.
If the parent can afford to make the loan, Hook still suggests they ask themselves how their situation would look if they never received the money back. “Run a projection and ask if you are willing to make certain sacrifices, if necessary,” he says.

Is it ever a good idea to lend money to your children? Hook says there are two schools of thought. Some parents say they’re going to help their children no matter what; others stand resolute and take the position that their children need to learn for themselves, even if that means they learn from struggling in a tough situation.

On the pro side, Hook says there’s nothing nobler in life than helping a child to get started. “Money should never be something you stick under a mattress,” he says. It should be used to create value, and philanthropy often starts at home. Many people see helping a child buy a home, finance an education or extricate himself from a bad situation as positive uses of money.

If someone has more than one child, Hook says, and makes a loan to one child but not the other, what does that other child think? A loan that is not repaid becomes a gift, in a sense. “That’s a whole new topic,” Hook says. “Do you want to give equally to each? Now you are doing something for one, but not the other.”

Being asked for a loan by a family member is probably among the most emotional issues, almost akin to the stress of divorce. Sometimes, Hook says, all common sense goes out the window.

Other cons could be the stress that the loan creates for parents, and even the blow-up of a family situation. Some people see bailing a child out as enabling them, essentially teaching them that they don’t have to deal with something themselves. “At some point, we won’t be here, and they’re going to have to learn,” Hook says. “That’s a tough one.