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Is it a Good Idea to Loan Money to Your Children?

May 26, 2016 | Financial Planning, Lifestyle | 1 comment

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There was a time not long ago when young adults just starting out could easily enter the property market. It wasn’t unusual to own your own home long before you hit thirty, and perhaps even upscale before you hit that fourth decade. But the days of buying a house without a substantial deposit are gone, with the average first-time home buyer nowadays in their early forties. What this means is that many young and even middle-aged adults are having to turn to parents for loans, in order to buy a home. But is it a good idea to loan money to your children?

All parents want to be able to help their children get ahead in life, but there’s much to carefully consider as a potential lender, and surprisingly, it’s not all just about the money. Here are our thoughts:

Can you afford it?

While no one wants to deny their children, we believe that very often the decision is based on emotion alone and very little thought has gone into the financial impact on oneself. If you clearly have surplus funds available beyond your financial plan, then of course it is an easier decision. The bottom line is that you need to consider your own financial situation first.

What does this mean? You need to first look at the impact of this kind of long-term (friendly) loan on your retirement plan. If you loan the money to your child, you may well be getting a lower return on your money than you need in terms of your financial plan. Whilst you may well be happy with this arrangement for a time, what if circumstances change for your child, and they become unable to make loan repayments to you? What position would that put you in? Also, what is the potential impact of this kind of loan on your other children? Would they expect the same from you, and would you be able to deliver?

Taking a critical step back, the key question you need to ask yourself is: can the loan be accommodated within my financial plan? Without knowing the answer to this, you cannot assess what you can afford to part with. It’s critical to have a thorough understanding of your own financial plan before making this big decision, which can easily be clouded by emotion.

Gift vs loan

When parents have surplus assets that could be excluded from their financial plan, it can be better to give the money rather than to loan it, with the understanding that this gift is an advance on their inheritance. A loan attracts interest and is taxable in your hands, while a gift, which is considered a donation, carries a different tax implication. If you gift the money, a donations tax of 20% (of anything over R100,000 per year) will apply.

Then there is also the issue of fairness to siblings. Generally, if you gift money to one child, you would want to have a provision in the same amount for your other children (the same goes for a loan). All of this potentially needs to be reflected in your Will.

Have a contract

If you do decide to enter into a loan agreement, make sure that it is an actual written agreement and not just a handshake. You should have a contract which ensures your agreement doesn’t erupt into chaos, especially if one of the parties dies. The contract should set out the loan amount, the repayment period and any other conditions, and should be signed by all parties and witnessed. Specifically, the issue of interest charged needs to be spelled out.

Loaning money to your adult children with clear terms and interest payable is an important way of educating them about finances and helping them to stand strongly on their own two feet. Therefore, it’s important that you take a business approach, and that they clearly understand what their obligations are to you.

Are you considering extending a helping hand to a child wishing to enter the property market? We strongly recommend that you have your annual financial review before making this big commitment, which will enable you to fully consider the financial impact on you.


1 Comment

  1. Marianne Balarin

    How well you describe the implications of a loan to one’s children. I wish I had found a similar article before I concluded the “deal”.


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