We all want to help when someone is in trouble. But helping someone out of financial trouble can come with unexpected costs and consequences. It is for that reason that I strongly advise against ever loaning money to family and friends.
On today's show we hear three stories:
- Mabel is a widow who chose to help her adult son who was struggling financially after a divorce. In the end, Mabel ended up maxing out her own line of credit and was having trouble keeping up with her own rent and debt payments.
- Larry loaned his son money for a down payment on a new home. Unfortunately, Larry's son separated from his wife who received the house as part of the separation agreement. Larry's down payment went to his son's ex-spouse.
- Amanda's parents gave her the 5% down payment she needed to enter the housing market. Unfortunately Amanda quickly found out she couldn't keep up with the bills associated with her new house. Maintenance, a job loss and a flooded basement resulted in her selling the home for less than she owed including some additional credit she incurred trying to keep up.
What's common about all these stories we heard on today's podcast is that in each case, loaning money to someone to 'help out' ended up with very bad consequences for everyone involved.
There are plenty of reasons not to loan money to a friend or family member:
- If they don't pay you back, you could jeopardize your relationship.
- Other family members may expect the same treatment or become resentful if you are seen to be favouring one child with money over another.
- If you have to borrow money yourself, this can lead to your own financial struggles, even your own bankruptcy if you are not repaid.
- You may be enabling bad spending behaviour by bailing your friend or child out, rather than forcing them to deal with their money problems on their own.
Sometimes the best help you can give is no help at all. However if you do want to do something, ask yourself these questions first:
- Can you afford it? I recommend gifting money over loaning them money. That way you only gift money you can afford. Also, if there is no obligation to pay it back, there is less of a chance that the gift will create friction between you. If they pay it back, you will appreciate the gesture and the friendship will last.
- Are you really helping? Again, this goes back to enabling bad financial choices. If your child can't afford to maintain their new home, you are doing more harm than good. If they know they can turn to you for a loan, they will never learn to save or live within their means.
The Helping Family Financially Checklist
The simple solution is don't loan anyone any money. However, if you really want to help out, follow these principles:
- Gift the money with no expectation of repayment.
- If you can't afford to help financially, say so up front.
- Don't loan money to someone who isn't taking responsibility for their own finances.
- Protect yourself if you can (like taking out a second mortgage) however recognize that events like a divorce may mean you will lose your money anyway.
- Lastly, think about Thanksgiving or Christmas. Will your help bring everyone closer together or cause more family arguments and stress?
Listen to the full podcast to hear more of my thoughts and reasoning behind why you should never loan a family member or friend money. The full transcript is also posted below.
FULL TRANSCRIPT show #110
Today I want to talk about something that gets a lot of people into trouble: loaning money to family and friends.
I understand the issue. You’ve got some money, your family member or friend needs some help, so you help them.
That’s what decent human beings do, right?
Yes, but it can cause problems.
Let’s start with a story about Mabel.
Mabel is a widow, 65 years old, with three grown adult children. She is a really good person. She is kind and giving, and never complains or asks for anything for herself. Her son, Randy, went through some tough times. He lost his job, and then went through a divorce. He needed a place to live, so he moved back in with Mabel for a while, and then she loaned him money for lawyer’s fees for his divorce, and she loaned him money to take care of some of his debts and for first and last month’s rent for a place of his own. Mabel is on a pension, and doesn’t have a lot of money herself, so she borrowed against her line of credit to get the money for her son. He promised he would pay her back, but he still hasn’t found a good job, so now Mabel is maxed out on her line of credit and is having trouble covering her own rent and her debt payments.
Sadly, this is a very common story.
I have met with many “Mabels” over the years, and they are all good people, wanting to do the right thing.
Unfortunately, if you borrow money to help someone, and they can’t repay you, you can end up in serious financial trouble, and may even need to go bankrupt yourself.
I have genuine empathy for people like Mabel, because she was honestly trying to help, with no regard for her personal situation. I assume that her son Randy was also genuinely thankful for her help, and had every intention of repaying his debt in full.
Unfortunately, life happens, and when Randy is unable to pay back the money, Mabel is left in a very precarious financial position.
In my experience, this is most common with seniors. “Once a parent, always a parent”, as the saying goes, and it is difficult for a mother or father to view their offspring as anything other than their children, because that’s what they are. We are genetically programmed to help and protect our children, which is great for the preservation of the human species when the children are young, but it is of less value when the child is 40 years old. It’s difficult for a parent who has always helped their children to say “no” to their requests for financial assistance.
For me, I have one strong recommendation:
Never loan money to family or friends.
Because if they are unable to repay you, you may lose a friend, or suffer irreparable harm to your family relationships. Thanksgiving dinner isn’t a lot of fun of the topic of conversation is “when are you going to pay me back that money I loaned you?”
How to Say No (or Yes)
So what should you do if a friend or family member asks for financial help? Here’s my strategy:
First, and most importantly, you should determine what help you can actually provide. If you have a million dollars in the bank, and your son asks for fifty bucks to fix the flat tire on his car, you will not suffer any adverse financial consequences if you help your son. If you are Mabel, on a fixed income, and the only way you can help is to put yourself into debt, you should seriously consider whether or not you want to jeopardize your financial future to help your adult child.
If you can’t help, say so.
I can think of many people who had to file bankruptcy because of the debt they incurred to help their adult children. They just couldn’t say no. When they finally went bankrupt, and lost all access to credit, they had one profound feeling: relief. They could honestly tell their children “sorry, I would love to help you, but I have no credit, and no money, so it’s impossible for me to get the cash to help you”. Not having the money is the perfect excuse for not helping, because it’s the truth.
My point is that you don’t have to wait until you file bankruptcy to say no. You don’t owe anyone an explanation, but if you feel compelled to give one, tell the truth: “I don’t have the financial resources to lend you money. I can’t put myself into debt, and jeopardize my retirement, to help you out. I can’t”.
What if you are financially stable, and you can help out without jeopardizing your financial future? The next question to ask is: “should I help?”
At some point we all must “grow up” and fend for ourselves. If you continually bail out your friends and family, they will have no incentive to take care of themselves, by reducing their living expenses, getting a better job, and working hard.
Think of it this way…
Would you helping a gambling addict by giving them money to gamble? Would you help a person with a drinking problem by buying them a drink? Would you offer a match to someone who is trying to quit smoking?
So in the same vein, why would you help someone with a spending or saving problem continue to live beyond their means?
Sometimes the best help you can give is no help at all.
But what if the person genuinely needs your help? What if your daughter is going through a separation and needs help to find a place to live, until she can get back to supporting herself? What if your son has a medical issue and requires medication, and he can’t afford it?
If you decide that you have the resources to help out, and they really need your help, my advice is the same: don’t loan them money. However, if you feel so inclined, give them the money. No strings attached, no conditions, no expectation of repayment.
Why a gift and not a loan? Because there is no legal or moral obligation to repay a gift. The recipient does not have to feel that they are indebted to you. (They may feel that way, but it’s not a legal obligation). You do not have to worry about whether or not you will ever be repaid, because there is nothing to repay; it was a gift.
If you have the money, and if they really need it, give it to them.
If they say they want to pay you back, say “fine, but don’t even think about it until you are back on your feet”.
But what about loaning your children money for the down payment on a house? Isn’t that a good idea? What’s wrong with a parent helping their offspring get a good start in life?
Again, there are two questions to ask: “can I afford it, and am I actually helping or harming my kid?”
Let’s hear another story:
Larry bought his first house 30 years ago, and he’s owned four houses, and every one of them went up in value, and he wanted his adult children to also benefit from home ownership. He gave his oldest son $50,000 towards a down payment, and he planned to give his two daughters a similar amount when they finished university and were ready to buy a house or condo. Larry’s son split up with his wife, and she got the house as part of the separation agreement; Larry’s down payment was gone. Larry had some business issues of his own and was unable to help his daughters when they were ready to buy, and they now resent the fact that their older brother got money from Dad, and they probably won’t.
This may sound like a fanciful, made up story, but it isn’t. It’s very common, actually.
As a parent you have an additional decision to make: will I help all of my children equally? If your family is like every other family in the world, each child is different. They have different jobs and different earning capacities. Some are married, some are not. Some want to settle down and buy a house; some prefer to be mobile and rent.
If you are the parent, it’s your money, so you can loan or give it to your kids as you see fit. But, if kid #1 gets money and kid #2 doesn’t, will that create friction? Will Thanksgiving dinner be uncomfortable? Is that what you want?
Let me repeat my advice again: don’t loan your kids money.
Now I get it. You understand why it’s dangerous to loan your kids money, but you want to help, regardless of what I say.
Since you won’t take my advice, here’s what you should do if you really want to help them out.
First, think of all of your children together. Kid #1 needs help today, but Kid #2 may need help tomorrow, so don’t spend all of your money on Kid #1 and have nothing left for Kid #2.
Second, do the math and determine what you can afford to give them, on the assumption that they will never pay you back.
Third, let all of the kids know what the deal is.
The deal may be “Kid #1 needs help, the rest of you are fine on your own, so I’m only going to help Kid #1”. It’s your money, you can do that.
The deal may be “I have $300,000 in investments that I probably won’t need, and that money will probably be your inheritance when I die, so I’m going to set aside $100,000 for each of my three kids, and I will give them that money when they are ready to buy a house, or start a business, or go to school, or whatever other suitable purpose they have for it. It will be a gift, not a loan”.
While I believe we should all learn to fend for ourselves, it’s your money, and you can distribute it as you see fit.
What about a second mortgage?
Instead of gifting the money to my child, should I loan them the money to buy the house, and secure it with a second mortgage? Yes and no.
If Larry had leant his son the money and secured it with a mortgage, when his son got divorced Larry would still have a claim on the house, so in the separation there would have been less equity to distribute between Larry’s son and his ex-wife. That’s why a second mortgage is a good idea: it protects the lender in the event of a marriage break up, or if the borrower has to declare bankruptcy: the equity, up to the value of the mortgage, goes to the mortgage lender, not the other creditors.
However, loaning money to a child to buy a house may complicate the process of getting a first mortgage. It may be necessary to tell the bank you “gifted” the money so your child qualifies for a mortgage, so you can’t register your second mortgage until the financing is in place. It costs money to register a mortgage, and you have to agree on repayment terms, if any.
Let me emphasize again the two salient questions: can you afford it, and are you helping your kid?
If you can afford to lose the money, whether it’s a gift or a second mortgage is less important.
Of more importance is whether or not you are helping your kid by loaning or gifting them the money to buy a house.
I can tell you many stories of parents who provided the money for a down payment, and as a result the kid bought a house much bigger than they could reasonably afford, which caused severe financial pressure for the kid, because the cost of a house is more than just the cost of the mortgage. It’s great that mom and dad helped with the down payment, but they probably won’t be helping with the utilities, property taxes, and repairs and maintenance, so by “helping” junior buy a house they may in fact have subjected the poor kid to many years trapped in a house they cannot afford.
The issue is that the future is uncertain.
Your child doesn’t expect to lose their job, or get divorced, and they don’t expect that the real estate market will ever decline, but stuff happens.
The correct answer, in times of trouble, may be to sell the house, reduce expenses, and rent for a period of time until their situation improves.
However, if I’m the child and selling the house means I won’t be able to fully repay my parent’s loan, I may decide to hold on to the house until I’m back above water. I feel obligated to repay my parents, so I continue to own when I should be selling. The house becomes an anchor, holding me in place when I need to move. I’m trapped.
If house prices go up, and junior gets a promotion at work and has a long and successful marriage, your second mortgage will be repaid, with interest, and everyone will live happily ever after. That would be great.
However, if junior gets transferred to another city and has to sell the house, quickly, at a loss, and is not able to fully repay your loan, you have a problem. If junior gets divorced or loses his job or if the real estate market corrects, junior may not be able to repay your loan in full. Now junior feels bad, you are upset, and the other kids are worried that you won’t be able to help when they need your assistance.
The Bail Out
There is a final category of help that I see all too often: The Bail Out.
Here’s Amanda’s story:
Amanda’s parents gave her a 5% down payment so she could buy a house. The maintenance costs were more than Amanda expected, but she managed by using her line of credit to pay the bills. Then Amanda lost her job and got behind on her mortgage, so her parents gave her the money to catch up on the mortgage, but they didn’t have enough money to help her catch up on the property taxes, and when the basement flooded Amanda didn’t have the money to make the repairs, so she ended up selling the house at a loss. She was not able to repay her parents for the down payment or any of the bail out money.
Again, this is a very common story. It is not uncommon to help someone pay their debts, only to lose the house anyway.
Buying a house with 5% down is a recipe for disaster. If the real estate commissions will be 5% when you sell the house, you have no equity, so no margin for error. You can’t afford any surprises, like a leaky roof or flooded basement.
When you are that close to the edge, money to cover extra costs is usually throwing good money after bad. It was probably inevitable that Amanda would lose the house, so her parents did her no favors by delaying the inevitable. She should have sold the house sooner, and that would have saved her parents a lot of money, and grief.
It's your money, so consider the future carefully before financially assisting friends and family.
So let’s wrap this up with my practical advice.
The Helping Family Checklist
The simple solution is don’t loan anyone any money. If you really want to help, give them a gift with no expectation of repayment.
Whether it’s a gift or a loan, before you do anything, answer these three questions:
Can I afford to help? This question is critical. If you will need to borrow to help your family, you can’t afford it. The answer is no. You can’t afford to help, and helping out will only put you in deep trouble, and may even lead to your own bankruptcy.
Will helping them financially really help long term? Giving your kid the money for a 5% down payment to buy a house they can’t afford is harming, not helping. At its best you are enabling bad financial decision making, at its worse you’re setting them up for further financial disaster. Don’t do it.
If I decide to help, how can I protect myself? Registering a second mortgage after loaning the money may protect you if the house must be sold, but if they divorce or can’t make the payments you may still incur some costs to collect.
I know of many families who have been irreparably harmed by “helping out”, and that’s why, if possible, I suggest you avoid loaning family members money.
My final piece of advice:
Think about Thanksgiving, or Christmas, or whatever the next family gathering will be: will your financial help bring everyone closer together, or cause more stress?
It’s your money, so it’s your decision.