In many families, parents are more well-off than their adult children. They’ve had more years in the workforce, which means more time to increase income and to build savings. And some parents may want to use their excess earnings or accumulated wealth to help their offspring.
A financially stable parent can identify many ways to give an adult child a financial boost: funding a college education, starting a business, or buying a car are a few reasons parents might loan or even give money to their adult children.
“I typically see that lending occurs around home purchases,” said Joseph Bogardus, a financial professional with Barnum Financial Group in Shelton, Connecticut.
Lending among loved ones may be more common and less fraught than you think. More than half of Americans surveyed had made or accepted a loan from friends or family over the previous year according to a November 2020 study by LendingTree, an online loan marketplace. Almost two-thirds of those who borrowed or loaned money reported no negative consequences.
- Impact on your parents
- Parental control
- Effect on your credit score
- Conditions of acceptance
Thinking through the implications before you borrow can help you make the best decision for your —and your parents’ — circumstances.
Impact on your parents
Parents are often willing to make sacrifices to help their kids. But you may not want to accept a loan from your parents if they haven’t met their own financial needs yet.
“Can Mom and Dad afford to help?” Bogardus asked. “Do they have excess debts from college student loans? Do they have pensions to supplement longevity? Are they prepared for long-term care?”
Your parents may not be willing to discuss their finances with you; money is often treated as a taboo topic. (Related: 3 money taboos...and why you should break them)
But adult children should try to make sure their parents have the capacity to extend a loan without harming themselves. Not only is it a compassionate thing to do, it’s also practical: If your parents don’t take care of their own finances, who do you think will have to help them later? (Related: 9 financial questions to ask your mom)
Here are some questions to consider before borrowing money from your parents:
- Are your parents maxing out their retirement savings accounts?
- Is their home well maintained and in good repair?
- Are their vehicles well maintained and in good repair?
- Do they have a robust emergency fund?
- Have they mentioned carrying credit card debt, taking out a loan, or financing a purchase?
If your parents’ finances are not ideal, you might encourage them to use the money to improve their own circumstances instead of lending it to you. You may even want to visit a financial professional together.
On a popular TV show, the matriarch offers to pay for her granddaughter to attend a private high school. The catch? The granddaughter and her mother — the matriarch’s daughter — must have dinner at the grandmother’s house every Friday night.
It’s a big ask: the mother finds her mother the matriarch to be overbearing and prefers to keep her distance. Yet, the mother accepts the money and the strings attached to it because the arrangement will give her gifted daughter far better educational opportunities. Plus, the granddaughter adores her grandmother.
The mother has to weigh the difficult question that anyone accepting money from their parents does.
- What will feel worse: being indebted to your parents, going without, or finding another (potentially costlier) source of funds?
- And what kind of say will your parents feel they have over your future decisions if you accept the money?
- If you borrow money to buy a home, will they expect you to live close to them, get their approval for the home before you make an offer, or get mad if you buy a new couch before you repay them?
- If the loan is to start or grow a business, will Mom or Dad expect to have input on important business decisions?
The arrangement is more likely to succeed when parents honestly and clearly communicate any expectations surrounding the loan.
Effect on your credit score
One reason you might consider accepting a loan from your parents is if you have a limited or damaged credit history and can’t get a loan or a favorable interest rate from a financial institution. Someone who knows you as well as your parents do can tell the difference between damaged credit due to irresponsible behavior and damaged credit due to bad luck like layoffs, health problems, or identity theft.
Be aware that borrowing money from your parents will not help you build a credit history or improve your credit score. To do that, you’ll need to borrow from an entity that will report your payment history to the major credit bureaus. That doesn’t mean you shouldn’t borrow from your parents; just that you need to take additional steps to work on your credit. To limit your reliance on the Bank of Mom and Dad in the future, you may want to open a secured credit card to build your credit score.
Alternatives to accepting a loan from your parents
If you think that borrowing money from your parents may not be in your best interest or theirs, consider these alternatives, some of which depend on what you need the money for.
- Personal loan: With good to excellent credit, you can borrow money for any purpose at single-digit interest rates. These loans have fixed terms, so you’ll have to be disciplined about making the same payment every month, but you’ll be out of debt in a few years — sooner if you repay the loan early. (Related: Shopping for a loan)
- Low-down-payment mortgage with PMI: You can get a conventional mortgage with a down payment as low as 3 percent by paying a little extra each month for private mortgage insurance. You can drop PMI once your home equity reaches 20 percent. (Learn more: Buying your first home)
- Auto loan: Car dealerships can be fairly forgiving when it comes to credit standards. You may not get the lowest rate if you don’t have the best score, but you may be able to help offset that cost by choosing a reliable used vehicle that’s reasonably priced.
- Student loan: Federal student loan interest rates are relatively low and repayment terms are generous. Your credit isn’t a factor. And these loans also have built-in protections that can help if you become unemployed or underemployed. (Learn more: How to pay for college with Direct student loans)
- Home equity loan, home equity line of credit, or cash-out refinance: If you’re already a homeowner, borrowing against your equity can be a cost-effective way to get the cash you need. The catch is that it’s a secured loan, so if your new monthly payment would be a stretch, you could be putting your home at risk. (Related: The pros and cons of home equity loans)
- Help with one monthly bill: Instead of taking a loan from your parents and repaying it, would they be willing to pay one or more of your bills for a predetermined number of months? Perhaps they could cover your health insurance premiums, cell phone, or car insurance.
How to ask to borrow money from your parents
If you’re going to accept a loan from your parents, taking the following precautions may help avoid misunderstandings and keep your relationship strong.
- Set clear expectations. If your parents are lending you money to buy a car, do they expect you to buy a certain make and model? If the loan is for school, will they require you to get your degree in some particular field, like biochemistry?
- Establish a realistic repayment plan. Determine when you will begin repaying the loan, what your monthly payment will be, what the interest rate will be, and when the loan will be repaid in full. For an educational loan, maybe you agree to pay $100 a month when you’re taking classes full time, and $300 a month when you’re working full time.
- Discuss what will happen if you can’t make payments. Will your parents extend the loan term? Forgive missed payments? Under what circumstances?
- Draw up a formal contract or promissory note. Formalize the discussion about your repayment plan in a written document. It will avoid possible confusion later and may also be helpful for tax purposes if you are paying your parents interest. As far as the IRS is concerned, interest is necessary if the loan is for $10,000 or more. Otherwise, gift tax implications may arise. (Learn more: Lending money to family: Is it a good idea?)
- Examine tax implications. When parents loan money to adult children, two types of taxes might apply: income taxes and gift taxes.
- Income taxes: If your parents charge you interest, they need to report it as income on their tax returns.
- Gift taxes: “They need to make sure that they work with a tax professional to ensure that the loan is structured appropriately and not considered a gift,” Bogardus said. “There are special tax rules that must be followed.” For example, your parents must charge you at least the applicable federal rate to ensure the IRS classifies the transaction as a loan.
The bottom line
When your parents have their own finances in order, accepting a loan as their adult child can be mutually beneficial. If they’ve offered, they clearly want to help, and seeing you succeed as a result of their assistance can be rewarding. For you, the benefit may be a lower interest rate or more generous terms than you could get from a financial institution. If everyone agrees — in writing — on the loan’s terms and any parental expectations, accepting the money can be a smooth experience.
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This article was originally published in August 2021. It has been updated.