Do Your Kids Need A Financial Bailout?

Alright. Let’s get the show on the road, so to speak. Well good morning everyone and today’s topic is, “Do Your Kids Need a Financial Bailout?” We’ve noticed an increase in questions from clients recently. I say recently in the last year or so about concern about helping kids out. Part of it due the economy, maybe the kids can’t find a job or got laid off from a job, medical expenses, accruing some debt that they can’t get out from under, those kinds of issues. So we wanted to share some real life examples. We’re not going to violate anybody’s confidentiality and details and all that kind of stuff. How to set things up, mistakes we’ve seen folks make. So hopefully we learn from other folks and situations where you just may not want to provide help, financially speaking anyway.

So, one of the first examples I’ll share with you and this is, I’ll give you some real life details because their mine. When Annette (?) and I first got married the first home we owned, we wanted to do a room addition. So rather than go to the bank, we went to my mother for a loan. I insisted with Mom, that we do everything by the book. And what I mean by that is we paid Mom back the money regular monthly payments with interest. The interest was more than what she would have earned at the bank in a CD at the time which is where her money was or had been. And then on top of that we hired an attorney, paid a legal fee to get the paperwork drafted so that Mom had a second mortgage on our house with a mortgage and a note and just as if she had lent money to an independent third party, that type of paperwork.

So if you’re thinking about helping out kids, family members, one of the first things you’ll always hear us recommend is if you expect the money to be repaid, or want the money to be repaid, is to treat it as a business transaction. And that means there’s written agreements in place that everybody signs off on, everybody knows and understands what the terms and conditions are.

So other situations where we’ve seen folks want to help out, of course, is buying a house, maybe a down payment for a first-time home buyer or just helping folks with some down payment money or move-in money. Again, you just want to stop and think things through. Is this a gift? Or is this money that you’re going to loan and you expect to be repaid. And you need to be careful about giving money, loaning money not so much from a financial aspect.

Let’s imagine for a moment that you could afford to give money to help someone out and it’s not going to have a negative impact on your own personal financial situation, is that really the best way, the best approach. Well maybe yes, maybe no. See, what I’ve observed is if you help someone out, you run the risk of taking away some of their independence, self esteem, self worth when you do that. Because they feel, they might feel… You run the risk of them feeling like, you know, somehow they’ve failed or couldn’t do it on their own as opposed to structuring it as a business transaction. Then, kind of like in my situation, you know Mom maybe could’ve given us the money. I didn’t want her to because I wanted us to maintain my sense of self worth, independence, self esteem, call it what you will. I took great pride and pleasure in paying her off early by the way. So the same analogy, you know, sometimes folks come up with medical bills or they’ve accumulated debt and folks want to help them, their friend and family members, get out from under that burden.

Well, it all depends on the situation as to whether or not I think you should help them out. And you’re fee do agree or disagree with me on this. So let’s take the situation of medical expense. And we’ve given clients opinions both ways on this. Somebody in the family has racked up, you know, tens of thousands of dollars or medical expense, should you help them out? Well, were they responsible on the outsight? And by that, I mean were they responsible enough to go out and purchase their own health insurance or did they have a job where health insurance was available, or did they intentionally not buy or take advantage of a health insurance plan? Well if they are going to be irresponsible, hmmm, you know do you want to help out and foster that kind of behavior?

The flipside, you know, if they were doing the right thing, the responsible thing and just circumstances got the better of them, then maybe you step in and help out. I will tell you also we’ve helped clients and their family members negotiate medical and load debt down significantly from what the balance is owed. Especially medical, it’s not uncommon to negotiate fifty percent reduction for an immediate cash payment, just depending on the circumstances. And then sometimes with lenders, credit card companies especially, we’ve had mixed results. It just depends on the situation as far as negotiating a discount. So when one of our clients comes to us with the question of, “Hey, I’ve got a family member in financial difficulty they owe money whether it’s medical or debt,” one of the first things we do is encourage a lump-sum quick payment discount to lessen the burden. And then it’s between you and your friend or family member as to whether your participation, financially speaking, whether you’re going to treat it as a gift or as a loan.

And again, to repeat myself over and over again, if it’s going to be treated as a loan, then treat it as a third party business transaction just like you would anybody else and have everything in writing. Everybody signs off on it with interest, with collateral. Well, what if there’s not collateral? There’s not equity in anything? That’s OK, it doesn’t matter, still get collateral, whether it’s a car, a second, third, fourth mortgage on a home even if there’s no equity, that’s not the point. The point is you want to have some kind of collateral so that whatever asset the borrow is pledging, they can’t do anything with it without first paying you off, or at least getting your permission. And that avoids and can avoid significant family squabble.

And the other hint, tip, is sometimes we’ll see where clients have their children move back home. And when I say children, I’m talking about grown adults maybe in their twenties and thirties. They’re out of school looking for the first job or maybe they’ve started a career and gotten laid off due to the economy and they’re going to move back home. And often times that just creates tension and conflict, maybe not so much financially speaking, but just you know, hey, everybody’s got their own way of life and lifestyle and way of doing things and just their way of going about the day-to-day living. So what we always encourage folks to do is come up with a letter of understanding. In other words, if somebody’s going to move into your home, have a letter of understanding that says, you know, this is a situation that you expect to get resolved by… and plug in a date. Is it a week, a month, six months? Plug in a date. And then outline things like, are they going to kick in for food, utilities, are they going to borrow an automobile, do they have their own, cover all that stuff. What your expectations? And it’s OK if your expectations make them a little uncomfortable. That, maybe, gives them a little extra motivation and incentive to get back on their feet maybe sooner than what they would have otherwise done. Sometimes if you make things too comfortable for folks you make it uncomfortable on yourself.

So those are just some of the basic mistakes we’ve seen made. And then, there’s situations where we’ll tell folks we thing it would be a mistake to help a friend or family member out in a financial pickle, if you will. And situations like that typically can all be boiled down to irresponsible spending or poor decisions, bad money judgment. You know buying toys, if you will, adult big boy and girl toys like boats, RV’s, motorcycles that were just frivolous and shouldn’t have been done to begin with. Well, I’m going to suggest you don’t turn their problem into your problem. They dug the hole, so to speak, probably not overnight. Do not risk the harm that could be done to their own sense of independence and self worth by bailing them out. Let them crawl out of the hole themselves. Where there’s a will, there’s a way.

Often times natural human reaction would be to look for the easiest way out not that it’s an easy way out but look for the easiest way out. So instead of getting a part-time job to bring some extra income in and maybe they’re working 60-70 hours a week for a short period of time to get some debts paid off, it’s easier just to go ask for help; borrow money temporarily and all that kind of stuff. We caution folks about that. Know and understand what the purpose of, what the reason is, how these situations came about and if it’s from poor money management choices and decisions, then we think often times it’s better to just let that person to solve and fix their own problems.

You may have heard of Warren Buffet, Berkshire Hathaway fame, considered to be one of the most, if not the most, successful investors of our times. In his books that I’ve read about him, he’s often mentioned, quoted as not helping out his siblings. I think a sister, I remember specifically, fell on hard times and he obviously could have just written a check and bailed her out and he chose not to, really, for the reasons we’ve just been talking about. So food for thought in that regard.

And then there’s a couple of mistakes that you could make that could create or cause financial disaster for you. Some of the obvious ones, of course, are if you co-sign on a loan. I’m thinking of a car loan with you and a child, for instance. If they stop making the payments, guess what? It’s going to affect your credit. You have to come and make the payments, maybe end up with a car or a boat or an RV that you didn’t want. Again, general rule of thumb is don’t co-sign loans for anyone. Because what that really means is their credit, their income, isn’t good enough to qualify for the loan on their own. Well why on earth would you want to jump into that mess and take on that risk if a bank’s not willing to accept them as a lending loan risk? And yeah, you know, once and a while we’ll get the comment, “You gotta’ have credit helping them establish credit.” Here’s a thought, “There’s nothing wrong with paying cash either!” especially for things that go down in value as opposed to things that go up in value.

And then another big mistake and this happened recently to a couple of clients. You want to be careful about putting your kids on your bank account. And this is a common practice. In theory it makes sense especially for single folks. You know, if you’ve got adult children and you trust and have confidence in them and you want somebody on a bank account of yours just in case something happens to you and you want to give them access to your account, your money. And that thinking makes sense. Here’s the problem, and immediately two problems.

One is kind of obvious. If your kids have creditor problems, their creditors can come after you with any account that you’re jointly owned with one of the kids if the kids have creditor issues. But here’s the other thing to think about. Did you realize that if you’ve got a bank account, like your checking account at the bank, and a co-owner on that account is a child and that child gets a judgment against them and their creditor goes after their bank accounts and is successful in freezing your kid’s bank account, if they find out about your account jointly with your kid, they can freeze your bank account too. And the bank is obligated and compelled to do just that. If one of the kid’s creditors finds out about your bank account with your kid on the account with you, they can freeze your account. And that kind of scares me to think what would happen if that account happened to be the account where you’ve got, oh I don’t know, your pension and social security check being deposited every month and now it’s frozen. And now your bank can’t do anything about it. It’s up to the kid’s creditor to release things. It can create a potential mess.

So just some things to think about. We all want to help out our loved ones our kids and friends. But often times the best course of action is if you want to help them out treat it as a stand up business transaction. Have legal documents in place. Pay the attorney to do it and in return, you’re protecting that person’s sense of independence and self esteem and self worth. So those are my thoughts on helping your kids if they need a temporary financial bailout.

And with that, BT, why don’t we just open the lines. I think we got a few minutes for questions. Let everybody know how that works.

Sure, well we’ve got 12 minutes scheduled for the call, left in our budgeted time frame that is. And what I’ll do is I’ll open the phone lines. Right now they’re muted. There’s not feedback or noise going on the line while Brian was speaking but when we open up the line, if there’s a dog barking behind you or an airplane flying overhead or you’re in a moving vehicle, anything that’s going to be noisy behind you and is going to come over your phone, everybody on the phone call will hear that. So if you’d like to mute your phone where you are just hit *6 and then we won’t hear any of that noise behind you. But I will go ahead and un-mute the phones and it will be a party line. So just speak up ask your question. Announce your first name and ask your question and we’ll go from there. And here we go! Any questions?

Brian, this is Tony. Quick question, can you talk a little bit about…

No!

… thank you very much, my work here is done! Can you talk about the implications of interest rates for those formalized loans as far as collecting versus non-collecting?

You’re talking about….

Like somebody goes through the process of formalizing the loan but maybe they forget about the tax implications.

OK, yes. If you’re going to enter into a business transaction with a family member and charge them interests. One of the temptations would be to charge them a below-market interest rate. Well you need to be careful about that because there is a tax law on the books that will request you to charge or make you charge a minimum interest rate. And the interest rate is pulled from AFR tables. That stands for Applicable Federal Rate which are interest rates that the government says you must charge. And the rates, there’s short term, mid-term, and long-term interest rates that you must charge. And it just depends on the term of the loan as to what the interest rate is. In today’s environment, it still is a relatively low interest rate. But yes, you need to charge interest or otherwise you run the risk of the IRS treating the transaction as a gift. Not a problem if the loan is under $13,000. But if your loan is over $13,000 and the IRS comes back and treats it as a gift, not a loan, now you’ve got a taxable gift that you’ve got to deal with. Thanks, Tony, for that question. Sorry to have been teasing with you. Tony works here by the way.

It’s all right.

Ok, any other questions? Questions going once, going twice. Last chance to ask your questions. Just tells us your first name and ask your question. Well alright, I guess nobody else has any questions so we’re going to let everybody get on with the rest of their week. Have a great week, and we’ll see you next week with another Coffee Talk call. Have a great week everyone. Bye now.

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