As a parent, if your son or daughter asked you for financial support to assist with buying a car or because he/she had was in financial difficulty due to exceeding their credit card limit or towards buying a property, your natural inclination would be to help them out either by way of a loan or gifting them a sum of money.
Some of you might have heard the term “Bank of Mum and Dad” (BoMaD) that, typically, involves parents, grandparents or other family members lending money to their siblings. In fact, it is estimated by Legal and General (L & G) that around £5.7 billion will be lent by BoMaD to help their loved ones buy a property in 2018.
So, let’s have a look at some of the things you should consider if you are thinking of supporting your dependents financially.
Can you afford to help them?
Much as it would be lovely to help them out, you need to be comfortable that in doing so it is not going to stretch your finances. There seems little point in either lending or giving your son or daughter several thousand pounds of your hard earned savings if that is going to leave you worrying if you are going to be able to manage financially. Remember, you never know when you may need some of that “rainy day”, an emergency fund that you have accumulated. For instance, you may have to pay for expensive medical treatment or, if you were made redundant, require the funds to meet your household expenditure until you have found another job.
Hard as it may seem, don’t be frightened to say “No” if you are not comfortable in assisting them financially providing them with an explanation as to why you are not prepared to help them.
It is a different matter if you have had the foresight to plan and set up some form of regular savings plan to build up a fund that is earmarked to give to your children perhaps when they reach say 18 or 21 years of age.
Informal or formal basis?
If you are lending a member of your family money, then you need to decide whether to place the arrangement on an informal or formal basis.
An informal arrangement could be where you are quite happy for the person that you have lent the money to repay you as and when they feel that they can afford to do so. That could be by way of irregular amounts over an indefinite period, and things could have been agreed verbally.
A formal arrangement could be where the borrower and you sign a form of agreement that, for instance, sets out how much has been borrowed and the repayment terms i.e. the weekly/monthly repayment amount, over what period the loan is to be repaid and, if interest is to be charged, what the interest rate and amount of interest is.
It may be a cost that you could do without but you may wish to get some professional advice in this respect.
Could it cause a strained relationship?
If the loan repayments are maintained as agreed, then everything should be fine, and all parties will remain the “best of friends”.
However, do bear in mind that, if the borrower doesn’t meet their side of the agreement by, for instance, not making the repayments on time then this could cause friction in your relationship with your loved one that could have long-term consequences.
Do you charge them interest?
For whatever reason, a significant number of family loans are on an interest-free basis but do bear in mind that, if you had still retained these monies in a savings account, you would no doubt have been earning interest on them. So, why not consider charging a reasonable interest rate? After all, if your son or daughter had borrowed the money from a bank, they would have been charged a commercial rate of interest.
If you do charge interest then that is classed as income, and you may need to pay income tax on it, but you may wish to obtain some professional advice about this.
Is a guarantor loan or equity release better?
If you don’t have sufficient surplus savings to lend or give to your family member and if their credit is poor maybe suggest using a reputable loan broker that specialises in bad credit. He or she may suggest the likes of a guarantor loan with you acting as a guarantor or you may be able to arrange to release some equity in your property. If their credit history is the issue, advise them to try and rebuild their credit history.
Transfer the loan monies
As evidence of handing over the loan monies, you may wish to transfer the funds directly into the bank account of the family member borrowing the monies or give them a cheque rather than providing them with cash.
Gift or loan
If you are in the fortunate position of being able to either gift or loan the monies to your off-spring, then you may wish to obtain some professional advice from the likes of a solicitor who has expertise in inheritance tax planning as to the most suitable option taking into account your circumstances.
Hopefully, the above will prove to be of assistance if you are considering lending or giving money to a member of your family. From their point of view, if it is a loan, it is usually a very cheap way of borrowing money especially if no interest is payable and you will no doubt get an awful lot of personal satisfaction having been able to help them out financially. However, please don’t let your heart rule your head as you may end up regretting lending the money.
About the author: Sharon Pascoe has been a finance content writer for over 8 years and now writes for Finance and Lifestyle, the blog of First Quality Finance.