Billal
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Why you should never lend money to your children to help them buy a home, cars, etc.

Guest blogger Billal here for Mitch's financial freedom community !

Today's topic involve people that are very close to you in life... your kids.

So your little Billy and Bob are all grown up and ready to move out of their nest egg. Congratulations!

Unless you live in a quiet village, chances are buying a home will be something they need to save up for first, so like most people they will rent and work, rent and work, and so forth until they are able to afford their first home. Or at least the down payment to their first home.

What a lifestyle! Wouldn't it be much easier to just lend them a few tens of thousands of bucks to your kids to get them started, especially if you have the money and just expect them to pay you back? This is a tricky one... the borrower is slave to the lender, so relationships can go sour from this. If you must give your kids money to buy their first home, it is much better to just give it to them, or help them save up for it by matching their income.

Today I'm going to go over several reasons why lending money to your children is not a great idea.

One of the reasons is that interest rates are extremely low these days, at least at the time of this writing. It would be better for your child to borrow directly from the bank at the 3-4% interest rates if they really need the money and you could put your money to better use, such as investing in mutual funds with high returns. You would suffer from opportunity costs if you were to lend the money to your child with the expectation that they would pay back. Again, this is why I suggest just giving them the money if you want to help them out at all, or just have them work hard for their own house (recommended since acquiring a house through hard work is much more satisfying).

Another reason is that family relationships will almost always go sour, guarenteed. Think about this, if they default on their payment, you would never feel right foreclosing on your own child. So that usually doesn't happen. Instead, relationships just get bitter and phone calls are avoided.

The fact is lending money can cause conflict, no matter the cause. Banks do a lot of research on lenders beyond just checking their credit score. They check their employment history, area they live, crime rate of the area they want to live in, and other factors. They have a whole team to do this and you will never be at par with that level. This is known as risk analysis. Would you honestly feel right doing risk analysis on your own child? Chances are - no. You'll just trust them because they are your own child. This bias can lead to overconfidence and you lending them ten times as much as a bank would have.

Finally, you may incur a gift tax if you lend your child a large sum, which can be a lot of trouble. You have to document the loan. This isn't a big deal if you plug in the numbers carefully and know what you are doing. Consult with a lawyer!

If you do lend money to your child and don't pursue collection when they default on their payment, IRS will consider this to be a gift, and thus you may be taxed. If the loan is forgiven, as most often the case since parents do want to help their children out, then the child will have to report it as earned income and pay a huge tax on it. It's a lose-lose situation no matter how you look at it.

My question of the day is this... would you lend money to your child to help them buy a home? What are some better alternatives to support them instead? (it doesn't have to be related to finance)