Generosity can backfire
Parents need to make it clear whether any handout is a loan or a gift
Australians are generous when it comes to lending money. A recent study by RMIT University found that Australians hand out $1.65 billion a year in informal and unprotected loans to their family and friends.
But too often you hear about loans going wrong. Misunderstandings about whether it is a gift or a loan are common. Adult children sometimes pressure their ageing parents – some already with dementia – to lend them money that they promise they will pay back. Fights over loans can often tear families apart.
For this reason, before you hand over any money to your family, no matter how much you trust your relatives, think it over carefully. There is a huge risk that you won’t be repaid.
While some parents don’t count on being repaid by their kids and view the loan as an early inheritance, it is more common for them to make sacrifices to lend them money and count on it coming back. Also parents may end up needing the money for their own needs after all – in the event of a health crisis, accident or aged care – so it is always best to consider it as a loan, rather than a gift.
Ideally, you want a formal agreement that is documented and signed. This avoids confusion, particularly if parents want to protect their family money from their kid’s partner. If you borrow from a bank or draw down on your credit card, there are repercussions if the repayments aren’t met. Without a formal lending agreement, it can be tricky to be confident that you will get your money back.
But a visit to the lawyer could be quite expensive. For a loan of $20,000, paying a lawyer $200 to $500 an hour can be unaffordable. Then if you need to chase up the loan, you have to pay legal fees.
For this reason, there are some semiformal loan agreements emerging from entrepreneurs. The idea behind them is
Parents need to weigh up what is fair to all their offspring
that both parties agree to the terms and conditions of the loan. They also bring up issues that families may find it hard to talk about. “Doing nothing is the worst possible outcome,” says Tim Dean, CEO of the Credi lending platform.
Dean says he didn’t want to be the person who kept asking his son to repay him a $2000 loan, so he has designed a platform and app to take away the stress and friction from such arrangements. His app allows lender and borrower to personalise the loan by drawing up the terms and conditions through negotiation. It has payment reminders and triggers, plus late payment fees. “I want to educate him without arguing with him,” says Dean about his son Josh.
Dean was alarmed to find out that his son was only making the minimum repayment on his credit card debt, rather than paying it off earlier. He had some money earning less than 2% in a savings account that he could lend his son. “As a parent, I want to make a real difference to my son’s life,” says Dean. “I’m terrified that our children are getting into a debt trap through interest-only payments on credit cards.”
Certainly loans from parents can be a lifeline for their kids if they have a medical emergency or a car accident; or it can help them to pay off credit card debt or buy a car that they need for their job. Dean says the documentation helps because if you have a loose set of instructions, kids are secretly hoping that their parents will let them off the hook.
The average loan handled by Credi is $16,500 and the average term is 3½ years. Dean says he has priced the service for retail customers, with a fee of $10 to set up the arrangement plus $4 a month. There are extra fees for features such as attachments.
Dean says that people don’t want to make money from loans. “If you look at the average interest rate that people charge the borrower on Credi, it is obvious that people don’t want to make money from the loan. It is 1.5%, the same as the cash rate.”
Parents need to weigh up what is fair for all their offspring. If they help one child, should they help any others? It is important to make it clear. And if parents don’t expect to be paid back, should they take the loan into account in their will, so that their children are treated equally?