Friday, April 9, 2010

Use Caution When Helping Your Kids Get Out of Debt

The “Great Recession” of 2009-2010 has caused financial distress for many families. Many people have fallen hopelessly behind on their mortgages and other personal debt, including credit card and automobile payments.

Many seniors are now faced with the dilemma of whether, and to what extent, they should “bail out” their children or grandchildren. There is no “right” answer to this question. Each parent or grandparent has to look at the totality of the circumstances before deciding how to proceed. In my experience, those seniors who are able and willing to help their children and grandchildren climb out of debt tend to pay off their loved-ones’ obligations without taking appropriate steps to ensure that the situation will not repeat itself. The unfortunate result is that before long the child or grandchild finds themselves in a similar situation and comes looking for another “helping hand.”

Am I suggesting that you simply leave your beloved offspring at the mercy of their creditors? Not at all; it is natural to want to help your loved-ones get out of a financial crisis. I do recommend, however, that financial assistance come with “strings attached.” In the long run, conditioning financial aid on certain behavioral changes will help prevent your child or grandchild from falling into the same financial trap.

First, I would recommend that if the debt is of a substantial amount (say, in excess of $10,000), most if not all of the aid should be made as a loan rather than a gift. The loan should be memorialized by a well-drafted promissory note, with terms to include a regular payment schedule (typically monthly or quarterly), plus a reasonable rate of interest (anywhere from 3% to 7% would be reasonable in today’s economic climate). While in most cases the senior making the loan will not be interested in requiring that the child or grandchild provide collateral security for the loan (i.e., securing the loan by placing a mortgage on the borrower’s home), that option should be considered.

If you are paying off a mortgage, automobile loan, credit card or other debt, you should make the check payable directly to the third party creditor to ensure that the funds are in fact used to reduce or eliminate the child or grandchild’s financial obligation.

The lending parent or grandparent should also consider requiring the borrower to cancel all of their credit cards, with the possible exception of one card with a very low credit limit. Until the borrower demonstrates that their spending is under control, they should rely primarily on cash or a debit card. The child or grandchild should also provide the lending parent or grandparent with a current copy of the borrower’s credit report so that the lender can verify the nature and extent of the borrower’s debt.

One final recommendation: any assistance plan should incorporate financial planning and management assistance for the younger family member. Many young adults have never mastered proper budgeting or financial planning skills. In New York State, a reliable source for financial education can be found at Cornell Cooperative Extension. Among its many services, Cooperative Extension offers training in personal financial management and debtor education. To learn about the offerings at your local office of Cooperative Extension, visit The Cooperative Extension website provides general information and links to the various Extension offices throughout New York State. The Orange County Extension office, for example, offers a three hour personal financial management and debtor education course. Another excellent resource is America Saves (, a national coalition of over 1,000 non-profit, government and corporate groups.

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