When it comes to lending money to family, you want to tread lightly. It can be fraught with financial, legal, and emotional consequences for both you and the recipient, so it’s important to go into any loan arrangement with both eyes open.
The most common scenario we are asked about is lending money to children, and while we all want to help loved ones, where money is involved, the same rules apply. Here is our guide to what you should consider before lending money.
Hand-up or hand-out?
It’s important to think about how your loan will help the recipient. It can be a great way to give them a head start, but if you are fixing poor financial decisions, it could be the proverbial band-aid on a bullet wound.
When it comes to your children, it’s important to enforce good money management early on, or risk becoming the “Bank of Mum and Dad”. The goal of any loan should be to support their financial independence, not create an expensive dependency. Sometimes the best way to help your children with a financial mistake is to share your time and life experience to create a budget rather than your money.
What is the real cost?
If you are in the later years of your working career or already in retirement, you need to understand how the loan will impact your future too. You want to help your kids, but it shouldn’t be at the expense of your retirement plans. If you are receiving a pension, there are limits to the amount of money you can gift or loan before it impacts your payments. Other things to think about include:
- What return would you be making on the money if you kept it?
- How will losing that income stream impact your retirement plans?
- If you are going to charge interest, what are the tax implications?
- Can you afford to lose the money if it’s not paid back?
This last point is critical. Even if it is intended as a loan, you need to ensure that you aren’t relying on repayment for your own financial security. If you can’t afford for it not to be paid back, you can’t afford to lend it.
Is it better to gift the money?
While it’s important to get advice that takes into account your personal circumstances, generally speaking, the answer is no. Although it might seem like a nice idea to “gift” the money to a loved one, a gift can come with unwanted implications for both of you.
For the recipient, a lump sum gift can have unwanted tax implications. The money also becomes an asset belonging to the recipient, so if they are impacted by an event such as a divorce or bankruptcy, your money can be considered in any settlements. You might find your gift ends up being given to an ex-partner or swallowed by a creditor.
On the other hand, if your intention is to help your child with a house deposit, many banks won’t accept borrowed money, because this is viewed as a line of credit with repayment expectations.
One way you can get around this is to help your child with smaller, ongoing costs such as utility or grocery bills to help them put the money away for their deposit.
How will your relationships be impacted?
In our industry, we see it all too often, family relationships breaking down over money. This could be between the lender and the recipient because of inability to repay, or even between the lender and other family members who feel that they “missed out” or were against the loan in the first place.
The emotional implications of a family loan can be far-reaching and devastating, often feeling like a bigger “cost” than the loan amount itself. Before lending money to a family member, it’s best to have an open and honest discussion about expectations and put an agreed contingency plan in place to determine what happens if repayments can’t be met.
It’s also worthwhile to be upfront with any other family members who may have a vested interest, such as your other children. You may think keeping it quiet will avoid conflict, but these things tend to surface, and the secrecy can create bigger rifts than the initial loan.
How can you protect yourself?
The best way to protect everyone involved is to have a formal legal agreement drawn up that documents the loan amount, terms and repayments. This can protect you both from any unwanted tax implications and protect your money.
While it can be tempting to manage this without lawyers, personal written documentation and IOUs are much harder to prove or use as evidence should any legal issues arise.
It’s also important to speak to your financial adviser, who can take into account your life goals, retirement plans, and personal context to help you understand the full impact of the loan.
At the end of the day, a loan to a family member can be a great way to help them achieve their financial goals, but it’s essential to make sure it’s not at the cost of your own. You need to go into any loan arrangement cautiously and with expert advice to ensure you don’t find yourself bearing the financial or emotional costs.
General Advice warning
The information provided in this blog does not constitute ﬁnancial product advice. The information is of a general nature only and does not take into account your individual objectives, ﬁnancial situation or needs. It should not be used, relied upon, or treated as a substitute for speciﬁc professional advice. Apt Wealth Partners (AFSL and ACL 436121 ABN 49 159 583 847) and Apt Wealth Home Loans (powered by Smartline ACL 385325) recommends that you obtain professional advice before making any decision in relation to your particular requirements or circumstances.