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Lending Money to Your Adult Kid

That's right—it's probably not a great idea to lend your older kids money. But life is more complicated than that, right?

Consider these federal government stats: Unemployment rates have jumped 4 percent in the last six years, and most of the people out of work in this country are concentrated in their late teens (23 percent) and early 20s (13 percent). Of the nearly 50 million uninsured people in the United States those most likely to be without health care coverage are age 18 to 34, or earn less than $25,000 a year. This health care crunch, along with the rising cost of higher education and unemployment rates, can quickly lead to financial struggles, especially for young adults new to the job market or saddled with student loans.

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So, how can parents be smart about giving their financially flailing children help?

Research the situation. Ask critical questions of your children, advises Jean Chatzky, author of the recently released Money Rules. Why the money is needed? Does the child have an income? Does she have credit issues? (And how are they being resolved?) Is there a mortgage?

“It’s OK to say, ‘This can be messy. I am not saying no, but let’s look at all the options first. Is there a way you can borrow from a traditional lender?’” Chatzky notes.

Put it on paper. Writing down what the loan is for may help parents to make an immediate decision about whether or not to offer the money or, more simply, advise on how to manage the debt.

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“If your kid is short on cash to cover credit card payments for irresponsible spending, it’s not up to you to bail her out,” says Beth Kobliner, author of Get a Financial Life and member of the President’s Advisory Council on Financial Capability. “Consider it a lesson from the school of hard knocks.”

Just like a flight attendant instructs you to secure your oxygen mask before your child’s, I’m telling you to secure your own finances before you can help your kid.

Encourage your child to request a lower interest rate from the credit card company or transfer the balance to a lower-interest card, says Kobliner. (Compare rates at sites like nerdwallet.com or billshrink.com). But never co-sign on a credit card, she warns: “You’ll be on the hook for all their debts, and that could hurt your credit score.”

Ask to see an exact figure the child wants to borrow, a realistic plan for repayment and a plan for getting back on their feet. Calculate how interest will impact the amount of the loan and discuss how you’ll communicate about the money until it is paid down.

Get honest about your own financial well-being. “Parents need to make sure they can afford to give the loan,” says Kobliner. “Just like a flight attendant instructs you to secure your oxygen mask before your child’s, I’m telling you to secure your own finances before you can help your kid. If you’re not on track for retirement, or you’re paying off high-interest debt, then you simply can’t afford to bail out your kids. Remember your kids have more years than you do to earn, save and pay off a loan—so they’ll find a way.”

This is a prime opportunity for parents to be accountable for how they’ve taught their kids to manage money and get to the heart of why they now need a loan, Chatzky notes.

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“If there is no way kids can take out a loan from a traditional lender, ask yourself why there is no way,” Chatzky says. “What is the problem? Where is that rooted? Has the problem been solved? Is it only a lingering credit report issue? Or something bigger? Do I feel fully comfortable that my child is responsible enough to really pay me back?”

Before entering into a loan, one last option to consider is making a one-time gift to your child, she adds.

If you aren’t dependent on getting the money back and can be comfortable financially and emotionally, it may be better to offer your child the funds gratis. Once.

Make it official. “Start with a simple promissory note," Kobliner suggests. (You can download one for $15 at nolo.com). "And charge a small amount of interest, too.”

For loans of more than $13,000, Kobliner says the IRS expects that the borrower will be charged “applicable federal rate” (AFR). That rate varies monthly but now sits at 1.3 percent. Failing to charge interest, even to your children, could put you at odds with the IRS.

Charge a manageable interest rate even for loans under $13,000, Kobliner proposes, “as a symbol this is a ‘real’ loan, and that you expect to be paid back.”

Internet tools will help parents outline the terms of the loan and keep kids on track for repayment. Chatzky suggests using sites like virginmoney.com to create contracts and set up parameters that the lender can live with.

Get tough about getting the money back. If a child misses loan payments, it’s time for a tough talk and a budget review. Online resources like those at mint.com can help track monthly expenses. If your child thinks a loan from parents is code for “gift,” get tough.

“If it seems like he is not taking the loan seriously or taking advantage of your generosity,” Kobliner offers, “it may be time to pull the old ‘I’m disappointed’ talk and make clear the Bank of Mom and Dad is closed.”

And then ... give up. “The fact is, every time you loan money, there is a chance you’ll never see it again,” Kobliner says bluntly. “If you’re not comfortable with that, financially or emotionally, then consider that before you sign the first check.”

Have you ever loaned your children money? Did they successfully pay it back?

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