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Today’s young adults are finding it increasingly difficult to make the transition from college frugality to real world living. They face much greater challenges than their parents did, including a scarcity of well-paying jobs and much higher living costs – all while carrying a mountain of student loan debt around on their shoulders.
Recognizing this, an increasing number of parents are stepping up to offer unsolicited assistance to help their children gain their financial footing. Realizing you are an adult who must develop your own sense of responsibility (and because you may not yet be financially independent), the assistance typically comes in the form of a loan, not a gift. The question becomes whether or not you should accept it.
What Could Go Wrong?
As adult children, we are all desperate to demonstrate to our parents how grown and responsible we are. But, if your financial situation is such that you are going to miss bill payments or be forced to live out of your car, it shows more responsibility to accept your parents’ support than to fall prey to payday lenders or take up panhandling (you can decide which is worse). Pride is not a reason to forego parental financial support; it only gets in the way of clear thinking.
It’s a loan after all. It’s a business arrangement that will benefit you (getting you on your feet) and benefits your parents (giving them the satisfaction of helping you). Done properly, it’s a financial win-win as well. You’ll pay less in interest than you would if you could qualify for a loan on your own; and they will likely earn more in interest than with a bank CD. So what other misgivings could you have?
But, They’re My Parents
You’ve spent your entire life through your college years yearning to be a free, self-determining adult. You love your parents, but it’s your time now. Do you really want them to become your debt collector? Because they are your parents, they wouldn’t be nearly as tough as a real debt collector. They will probably be much more accommodating than a bank when you can’t make some payments.
But, make no mistake, they are your parents and, as your lender, they might feel they have more of a right to remind you of that, going as far as criticizing your spending habits or lifestyle choices. As Dave Ramsey likes to say, “When you borrow money from family members, they become the master and you become the servant,” which may be intolerable for some recently liberated young adults.
It really comes down to the type of relationship you have with your parents and the type of relationship you want to have with them going forward. If you have a good relationship with open communication and mutual respect during good times and bad, it should withstand the strain that a loan might bring. The more you can keep the arrangement at arm’s length, with formal terms, a written agreement, and contingencies for missed payments and such, the easier it is to separate the personal and business relationships with your parents.
Make Sure Its IRS Compliant
While it may not be a formal loan as if it were issued by a bank, the IRS makes no distinction in how it is treated for tax purposes. If the loan is for more than $10,000, the IRS will view it as a taxable gift from your parents unless a minimum interest rate is charged. The IRS publishes minimally accepted interest rates for family member loans of varying amounts. The good news is they are much lower than the interest you would pay on a formal loan. However, your parents will have to report the interest you pay as income and, unless you are using the loan to buy a house, the interest charges are not tax deductible. If you are using the loan to buy a home, your parents would need to hold a lien on your house.
When There is No Way, No How
If your relationship with your parents is such that you can’t trust them to stay out of your life, or they can’t trust you to live it responsibly, you probably shouldn’t accept their help. The relationship would only become more awkward than it already is. If you are in need of capital, your better option would be to obtain a personal loan on your own.
With the competition among new online lenders heating up, there is a good chance you could qualify for a reasonably priced loan. You would need a credit score of at least 600 and have a steady source of income. The loan can be used for any purpose and you can choose a term length to fit your budget. If things turn around for you financially, you can accelerate your payments to pay it off early. You won’t get an interest rate anywhere near as low as what your parents might offer, but at least you won’t have to share a table with your lender at Thanksgiving.
Author: Jeff Gitlen