Borrowing money is never simple, but when you borrow from friends or family members, it also has the potential to destroy relationships.
Tarah, a working mom in the Midwest in her early 30s, struggled with whether or not to help her parents buy a new car while she and her husband were trying to pay off their own debts. She ended up deciding not to help. "I don't want to think about dealing with that while I'm trying to stay focused on getting out of debt," says Tarah, who asked that only her first name be used. She says her decision created family tension.
As more families come under financial pressure, Tarah's dilemma—to help or not to help—has become increasingly common. According to Fidelity, 10 percent of generation X-ers provide financial support to their parents or in-laws, and the average amount is about $3,500 a year.
Experts offer these strategies for cross-generational lending:
First, decide if you can afford to give help. An Ameriprise Financial survey found that many baby boomers didn't realize how much the help they were providing cut into their own retirement savings. About 30 percent of baby boomers said the money they gave their adult children negatively affected their own retirement savings, but most were unaware of the impact.
Consider saying "No"—firmly. Declining a request for help, while painful, is sometimes the best decision a person can make, especially since many loans never get paid back. The top priority needs to be staying solvent oneself, says Ted Beck, president of the National Endowment for Financial Education.
If a relative asks for money unexpectedly, you should stall, suggest Jeanne Fleming and Leonard Schwarz, authors of Isn't It Their Turn to Pick Up the Check? "What you blurt out may not be the best answer," Schwarz says. Then, be sympathetic but firm. "You want to be unequivocal. Don't say, 'This is a bad time,' or they'll ask you again next week," Fleming adds.
Look for nonmonetary alternatives. Tina Kimball, a 30-something administrative assistant in Dayton, Ohio, loaned her parents her car when an accident left theirs unusable. If the situation worsened, she says, she would invite them to live with her family. Kimball says she wishes she could give them money, but with her own family finances under pressure, she's doing the most she can.
Put all loans and gifts in writing. Relatives lending more than $1,000 should draw up a simple document describing the terms of the loan, including the interest rate and schedule for repayment, recommends Jennifer Streaks, a financial services attorney in Washington, D.C. In addition to preventing misunderstandings, the paperwork can be important for legal reasons, too. This year, amounts over $12,000 are subject to gift taxes, and unless a certain interest rate set by the Treasury Department is charged—currently 1.63 percent or higher—loans could also be considered gifts.
Consider what might be expected in return. Donald Cox, professor of economics at Boston College, says that people who give or lend money to relatives are usually motivated by altruism, but sometimes something is expected in return. For example, if parents give money to their child for a down payment for a house or college tuition, they may expect assistance later. "Many adult children who are providing care for needy, elderly parents say they are doing this out of a sense of reciprocity," he says.
Learn from mistakes. Tales of family borrowing gone awry abound. Consider these examples from Alpha Consumer readers:
• Andrew lent his sister $10,000 in 2005 to help her pay off her bills and get out of debt. He expected her to pay it back, but she only repaid a small portion of it. He writes, "I rarely talk to her, and when I do, I don't want to pester her about the money. She recently purchased a house, and she has a family with three step-kids and one child of her own who is only a year old." He isn't sure what to do, and worries about tension around holiday gatherings.
The lesson: Family loans often don't get paid back, which can badly strain relationships.
• When Jay's mother had a stroke at age 50, he struggled over whether to lend her money. He was just 26, but with his job, could afford to give her some money. But he decided not to. He writes, "I know my mom. I know her history with money and jobs. I know what would have happened if I enabled her behavior." But he did pay her rent until she recovered. She ended up relocating to a less-expensive area and is making ends meet.
The lesson: Know your limits. Jay says that while his decision was difficult, he knows it was probably the best move. "Throughout my experience with my mom, she kept saying, 'I'll pay you back.' But I knew better."
• Julie had just turned 17 when her dad quit his job and opened a hardware store. He asked her to lend him some of the cash she had stored up from part-time jobs—money that was earmarked for school costs. She decided to lend him the money. "My parents had already provided for us and spent money year after year on our sporting activities. I determined if I could help, I would be glad to, as a way of saying 'thank you.' Also, by lending the money, I would guarantee that I wouldn't spend it and I didn't need it for three years," she says. She ended up drawing up a contract for the loan, which specified that her dad would pay her back with interest. She got her money back right when she needed it. "Things worked out in the end, and I am happy that I was able to give my dad a gift to help him out when it was needed."
The lesson: Sometimes giving a loan works out well for both parties. Also, written agreements can help.
The bottom line: Borrowing or lending money to family members can cause problems that go well beyond money. As for Tarah, she says the best thing she can do for her family is to avoid repeating her parents' financial mistakes. That way, she says, she can avoid becoming a similar burden to her own children one day.