The Bank of Mom and Dad – Episode 163

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[00:01] Welcome to the Prosperity Podcast, fresh alternative personal finance talk for independent thinkers who prosper outside of Wall Street. Here’s your host, bestselling author, Kim D.H. Butler and No BS Money Guy, Todd Strobel. Hey everybody, welcome back to the Prosperity Podcast. This is No BS Money Guy, Todd Strobel. Once again, we have bestselling financial author Kim Butler as our co-host today. And today we’re going to be talking about an article that’s in AARP Magazine. It’s the January 2017 edition and we’re going to be talking about the subject is the bank of mom and dad and we’re going to be discussing the four questions that you ask before saying yes to your adult children and then also discussing some scenarios and we’re kind

[00:54] of catching Kim off guard on this because we’re going to see if she agrees, disagrees or what her opinion is on each of these and she’s not heard any of this before. So welcome, Kim. Thank you, Todd. I am so curious to hear what the information is and just by way of quick background, a lot of people are either fans of or not fans of AARP and I will readily admit I used to be in the latter category than not fans of, but we actually have a client who’s one of the attorneys at AARP and separate from that, I ran across the book by Joanne Jenkins who’s the current head of AARP and I was quite impressed. So I’m so curious to hear what these questions are and the thought process behind them and as you know, I’ll always happily lend my opinion.

[01:43] Okay, well we got a lot to cover so we’re going to jump right in. So let’s start with the four questions. Question number one is, will this investment add stability and security to my child’s life or is it simply a good to have purchase or investment? Awesome question. So will it add stability and security? Now that is an interesting play on words because so often when the bank of mom and dad step in, the security and the stability that they’re looking to provide is actually false. So I’m going to kind of go on both sides with this. I mean, the question’s great. It’s a good question to ask and I think we do want to help our children develop self-oriented stability and to rely on themselves for their security.

[02:38] So I would have a corresponding question, which is, does the now use the term investment. So we’ll just go with that. I don’t really think they mean investment like investment. They mean investment like invest in the kids does providing this money, which is a better use of the verb, I think, add the stability and the security. And so you have to ask yourself. So I’ll just share a personal story. My daughter is in a gap year of college. She’s 19 and she absolutely is working and yet she needed a car and she didn’t have the ability to get the car on her own. And so one of the things that we did is help her get the car. But then we pay her and she pays her car payment. And I think that’s so important.

[03:27] It’s a little bit extra work on everybody’s part. But then she sees that money come in and go out every single month. She’s still responsible for her own gas and lube all filter and doing whatever else she needs to do to the car. She is still on our insurance, but same deal. She’s well aware. She gets her insurance card. She’s well aware of the cost of that insurance. And that, I think, up levels it some so that the stability and the security that are being provided by the car, which was clearly a necessary item for her to be able to work and do the other things, was then parlayed into still some really good education. So that would be my answer to the question is, yes, in this case it does.

[04:13] But it provides it in a way that it’s self-generated, that she can see the difference. So any other thoughts on that? No, like I said, I’ve seen clients have both, you know, I was involved in a situation where a client had a child who really struggled to get through high school. I mean, just it was just a very difficult thing. And the child wanted to drop out and buckle down and manage to graduate from high school. And they were so excited that they provided the down payment on a car. Again, he really didn’t have stable employment, but they provided the down payment and he purchased a, I don’t know what the brand of the car was, but it was a 500 horsepower car. And within six months, he got a ticket for going 70 miles an hour over the speed

[05:01] limit and lost his license. And now he can’t work, can’t drive, and they have to make the payments. So clearly that was not a good decision. It is amazing what happened. And now you and I just gave stories of what I would call very young adult children. I’m well aware of clients that are still helping their children when they’re in their thirties and forties. And I think that is actually causing their children problems. I think it is absolutely disengaging the security and the protection and the support that you are trying to get your, your child to have. So anyway, let’s go on. What’s the next one? Okay. Is this a short term or one time cash need, or is it something that could drag on for years?

[05:55] Yeah, that’s a fabulous question. And obviously the car payment that we just talked about, you’re talking three, four or five years in most cases. Yes, obviously the car could get sold. Okay, fine. But could it get sold and pay off the debt? That’s another question. So that’s a fabulous question to ask is what’s the timeframe and am I enabling somebody in this situation? And we don’t want to be enabling people. That’s, am I using the right word, enabling? Yeah, I think that’s what I’m looking for. Yep. I believe you are the next one is financially safe. Is there risk in the investment beyond the cash outlay such as financial liability on a contract or damage to your credit? Yes, that is a fabulous question.

[06:42] And so let’s bring up something that we’ve covered in the past, which is the liability umbrella, because clearly if you are on a car with somebody, whether you’re on the title or I think even the courts could probably find that if you’re making the payment, you have some ownership. Even if you don’t actually have paper ownership, both adults want to make sure that they have a liability umbrella and that’s a property and casualty oriented insurance policy that you get typically from the same place you get your car and your home insurance from. If you don’t have any access to that kind of conversation, let us know. We have a nationwide group that actually helps people shop car and home and liability insurance and a million dollar liability umbrella

[07:28] typically costs two to $300 or so. And then of course you can get 2 million or 3 million or 4 million. You should basically have an amount equal to your gross worth, not your net worth, your gross worth. Now, of course, a young adult’s probably not going to have anywhere near a million dollar gross worth, but that’s the minimum that I’m aware of. I could be wrong about that. But million dollar liability umbrella is a minimum of protection that the parents want to have in handling any kind of financial obligation that their adult children are dealing with. Okay. And then the final question is, I think my favorite one, and it’s, it’s about a being emotionally safe. Can you lend or give this money without fear of damaging your

[08:15] relationship with your child or will it cause tensions or resentments for the people involved? Wow. Yeah, that’s a fabulous question. And it, this time differentiates between lending and giving. And I’m really grateful for that because I think we need to be clear on that when we’re dealing with our adult children and potentially go so far as getting some paperwork so that the understanding is very clear at the outset, this doesn’t need to be overly fancy, just a quick one page memoration or that’s not the right word, memorandum of understanding and MOU it’s called memorandum of understanding, and it can just lay out the timeframe and the amount and the purpose, et cetera. And then I want to add a very critical aspect that I think is

[09:07] oftentimes missed and that is there should absolutely be interest associated with this loan. Now for two reasons, one, if it’s, if there is an interest, then it’s a gift and call it a gift and be done with it. I guess somebody could say, well, you know, I was expecting a principal to be paid back. But even the IRS wants interest charged on intra-family loans. But more important than that is those adult children that you are lending to, if that’s the choice that you decide to make, absolutely must understand that having dollars available costs money. And that’s what interest is. There’s a cost of money. Interest is a cost of money that we can put into a calculator and calculate. Now there is a minimum IRS number, which in today, as you mentioned,

[09:57] we’re at the beginning of 2017, it’s probably 3% or so, but I would encourage the family to be more conscious of what I would call market rates. If that adult child walked into a bank, assuming they could get the loan, which since they’re dealing with family loan, they probably can’t, assuming they could get the loan, depending on what it was for, you know, if it was a car loan, you’re looking at four or five, maybe 6%, if it’s some other thing like a couch or a vacation or what have you, I mean, those are credit card rates. You’re looking at 18, 19, 20%. And so it’s very important to have the family apply what is a market rate, interest rate to this loan. And by the way, if the adult child can’t get the loan at a bank, then their

[10:47] options are secured credit cards or other environments that could easily be 22, 23, 24% per year in terms of an interest rate. So that’s the interest importance on the adult child side. Now I’d like to speak a little bit about the importance of interest on the adult side. So the, the parent in this case, I’ll use that word. So the parent absolutely is taking this money from somewhere. Now we could all argue that bank savings accounts are not earning anything, but there’s still an opportunity cost associated with these dollars that are being taken from somewhere. And so if they’re being taken from a good investment that say earning eight to 10%, then they absolutely at a minimum would want to charge

[11:37] the child that equivalent rate. If there’s additional risk, like the fourth question, then they want to charge the child a little higher rate, or if they are taking it from just savings accounts that’s not earning anything, I believe very strongly that they want to charge the child a reasonable rate. So maybe you explained to the child, look, since you can’t get a bank loan, which would cost you 20% or 18%, I’ll do it at 10% or what have you. And you know, there’s an arbitrary rule that I’ll throw out that I think is helpful and that is that an 8% interest rate is a really good dividing line and it has been for years and years and years, doesn’t seem to really matter what the economy is doing and what

[12:22] interest rates are in the marketplace. If you have a loan that’s at 8% or less, that’s a pretty decent, fair, reasonable interest rate. And I know it seems really high right now, but we are in a very low, artificially low interest rate environment. Any loan that’s greater than 8% is getting up there. And so you can use that as a guideline, probably better than the IRS rates of 3% or whatever they are, but that 8% guideline is a good just rule of thumb interest rate that if you can get a loan less than that, it’s a pretty good deal. Super. Well, before we go on to the scenarios, I want to just mention that again, we are talking about money magazine, the AARP magazine, the January, 2017 edition.

[13:09] And what they do is they ask you to rate from zero to five, each of these questions and that if the score is 13 and up, it is reasonable to make the deal. If the score is 13 or below, you need to think twice about it. It doesn’t say not to, but it says to think twice. So got that. Yep. All right. So scenario number one is a dead car. Um, this is, uh, the child already has a car, but it needs to be repaired, uh, to get it back on the road, uh, so that they can realistically, uh, go to work. Right. Okay. So what I understand 13 is our dividing line, but I missed our total rating scale. What is that? Um, well, our total rating scale would be zero to five for each question. So our total rating would be somewhere between zero and 15.

[14:11] Adding them all up. Okay. Now AARP scores this one at 15, which is above 13. So they’re saying this is a reasonable time to step in and help your child. So I would agree, but I would again, reiterate that it should be a loan, not a gift ideally, and that it should absolutely have interest on it. And I’ll let you keep going with the scenarios. And then I want to share one more thing about the importance of understanding values when spending our money, but keep going. Scenario number two is the fairy tale wedding. Is negative an answer? Like zero. This is, uh, you know, uh, most weddings, according to this cost, uh, in excess of $20,000 now. Yeah. There is, um, certainly families that can do that and that’s fine.

[15:09] And yet I’ll just go ahead and launch into my comment on values for a moment. And that is that I think both the bride, the groom, and both sets of parents need to be involved in the discussion about the costs of the wedding and the reasonableness of them. And for families that can do that and the, the parents want to do that. And you know, maybe they’ve saved or they’re just going to handle it out of cashflow totally fine. But if you’ve got a child that’s out on their own, an adult child, and obviously that’s way more common today. People are getting married so much later. Um, that dollar figure really needs to be looked at is 20 grand. The best place to spend money in that child’s life that day.

[15:48] And, um, that’s a toughie. There’s a lot of emotion surrounded in that. So, um, I’m going to go with like five because I’m going to readily admit that there’s sometimes that that’s the value and that’s appropriate. And it’s okay for the family, but I just want a little asterisk by it to say that, you know, it’s okay. In fact, my own second wedding probably costs less than a thousand dollars, but it was a value play on our part. Well, uh, AARP magazine gave this one a thumbs down and said, you know, really, even if you can’t afford the wedding, you should offer them the ability to downside downplay the wedding and keep the difference to start their life together. I love that. I’m impressed. All right.

[16:37] Scenario number three, the apartment lease. This is a one truly case by case, but in general, if you are looking to justify a yes in many cities, a large cash advance is standard operating procedure and your kids need you, but you have to be circumspect. Okay. So this is like a, like a first and last month’s payment on the lease, or this is part of the monthly amount, uh, security deposits and all that stuff, you know? Yeah. So utility deposits. So I think that the kids should be dealing with that on their own. However, if there is just no other way to get it done. And especially if the adults, the parents are wanting the adult children out of the house and they’re not already, then that could be money very well spent.

[17:27] So I’m all right with the down payments and the first and last and the security deposits, et cetera. I am not all right with the helping with the monthly amount. That is absolutely something that people can find a less expensive apartment if that’s, uh, what their job enables them to pay for. That’s basically the exact same thing AARP says is that, you know, helping them get in the house in the property is fine, but you need to feel confident that they’re have the means and are responsible enough to make the monthly payments. Awesome. Scenario number four is similar. The home down payment. Okay. So I would basically say the same thing. You know, ideally the adult children should be saving for

[18:17] that and come up with that. And yet I’m well aware that sometimes that’s a big number. And if it does delay getting into a home, clearly having a home builds wealth better than paying rent. And I think that that’s a very reasonable thing for parents to step up for, but I also think it should be done as a loan, not as a gift. Again, every family’s situation is different there. You know, there could be money that was being saved for it earlier. Of course, we haven’t talked about borrowing against life insurance to fund these types of environments. And that can be a fabulous strategy for everybody involved. There’s cash value of life insurance that the parent owns, maybe even on this adult child where the insurance is on the child, but the

[19:00] parent owns the policy or it could be on the parent, they’re borrowing against that say at six or 8% lending it to the child at eight or 10%. Of course, you wouldn’t want to call that a loan for the mortgage company. It would need to be written down as a gift. Otherwise the mortgage company is going to be looking down their noses at it. But between the family, I believe that should really be a loan and those adult children should be making an effort to pay that back at a couple points above the life insurance loan cost. So let’s say the loan cost was six, then the adult children should pay it back at eight. If the loan cost from the insurance company was eight, then the adult children should pay it back at 10.

[19:44] And that’s a fabulous deal for the parents. That’s a 25% increase in value where you pay 8% for money and then you get 10% on that money, that’s a great deal for the parents. I have no problem with that at all. All right. Well, the second option of the same question is co-signing the mortgage. Oh yeah. So stay away from that. That’s a dangerous one. Now we talked earlier about the liability with co-signing on a car. Obviously this is a much longer term strategy and should absolutely be avoided. I think I suppose somebody could argue like, Hey, this is going to be a duplex and it’ll be a rental property and the kids are going to live in one half and rent out the other and it’ll be investment for everybody.

[20:30] Okay. I understand that. But as a general rule of thumb, if the kids can’t qualify for the mortgage themselves, then it’s probably too early for them to be getting a home. Again, we could argue, well, that’s more valuable than renting long-term. Yes, I understand that. But there are other ways to get a home bought without borrowing money from your parents for the payments and the mortgage payments in particular. The other side of that too, is that, you know, as an older adult, perhaps you’ve entered into retirement or you’re no longer working. So even though you may have substantial assets and savings, your monthly fixed income may be lower and a house payment, even on your children co-signing

[21:17] will be counted against your debt ratio by the bank. So you may find that you want to buy a condo or a second home or somewhere for vacation purposes and no longer qualify because of the obligation. So I think that’s important to remember too. Absolutely. Very good point you’ve made. All right. Next scenario is the divorce bailout. So one of your child, children get divorced. They have, you know, they’re now trying to live on their own where they’re used to have two income, two incomes, and they need to try to get things split back together, move in a new house or something like that and get their life restarted. Yep. Again, a toughie. Boy, aren’t they are emotional items that they’ve chosen for this list.

[22:06] So I would say that the divorce bailout is best not handled with the parents. I feel like divorce can be done very, very inexpensively. If you’re talking about a adult child that doesn’t have much financially anyway, there is no need to spend big money on attorneys. Now, if there’s children involved and there’s a fight over the children, okay, I understand that’s a bigger issue and there’s plenty of parents that truly do want the X out of the picture. And so then fine, you know, that’s again, a value decision on the parents, but please try to make it based on values and not based on emotion. And ideally don’t get involved in all. That’s a adult decision. The kids were the adult children were old enough to get married,

[22:52] old enough to get divorced and old enough to choose all the steps along the way that occurred to cause that problem. And I believe that they should solve it for themselves. Believe it or not, this one, you’re going to they’re going to disagree with you. This is their highest score of yes, this is when you need to get involved. Really? How interesting. Do they have reasoning for it? It just says that, you know, emotional and financial support at this time is critical for the future of your child and grandchildren. And absolutely, this is a time to go all in. Well, how about that? Isn’t it wonderful that we live in America and can have difference of opinions? All right. Scenario number six, the new business.

[23:43] Success stories from seeded parents, money seeded by parents money. Who better to invest in in your kids? Yes or no. Oh, that’s a toughie. If the parents have extra and they want to get involved that way. Sure have at it. But we all know the statistics. And yet I’m a very big fan of starting businesses. However, there are better ways to fund that, like crowds, crowdsourcing, crowdfunding, you know, using Kickstarter account or Indiegogo or something like that. So I think if those things had been exhausted, then maybe the parental discussion can be a part of numerous family dinner table talks to make decisions. As a general rule, if the parents were my clients, I would probably say no. But I would readily admit if the child was mine,

[24:34] I would be somewhat interested only because I’m such a fan of an entrepreneurial lifestyle. But I would really want to see something like Kickstarter, Indiegogo, crowd sourced, crowdfunding money pursued first. This one got the absolute lowest score of all of them in the big thumbs down. The only thing it does says, I think that’s important. That is, if you decide to help make it clear that you are now a business partner. Right. Good. OK. Scenario number seven is grad school. OK. So grad school on a right after college environment, in my opinion, is not a good match. And so I would not support that at all. I would want that child to adult child to go out, get some working experience, pursue other opportunities.

[25:30] Again, there’s financing available for that kind of thing. If they can get it, then they can have their grad school. If not, then I think their grad school is going to be a lot better if they can get some work done anyway. And then if it’s later, like they’ve worked for a while and now want to do grad school, I’m still going to hesitate. Now, I’ll admit a personal bias in that I don’t think grad school these days is very helpful in a lot of places. I think you’re better in on the job training. Of course, of course, there are some professions that absolutely require grad school. And unfortunately, the ones that do usually require PhDs and further schooling as well. So I believe that it’s something that the adult child

[26:15] needs to find a way through, because just like we’ve talked with college money, if they’ve got skin in the game, they’re going to get a lot better results out of their school. You are in complete agreement with AARP on this one. Awesome. Lined up on that one. One of the books that they recommend for additional information. I have not read this is a book by Bobby Rebel, R-E-B-E-L-L. And the name of the book is How to Be a Financial Grown Up. That’s fun. Sounds like an interesting title. Like I said, have not read it, but sure it’s available on Amazon. And Kim, I think you have some information that you’d like to offer to our listeners as well. Absolutely. We always want to expose people to our financial planning

[27:07] has failed e-book that is available as an audio book as well, especially for podcast listeners. And that is at partners number four, Prosperity.com slash e-book, both the e-book PDF and the audio book are there. And we welcome any comments about that and any questions that we can cover on the podcast should come to hello at partners number four, Prosperity.com. That’s hello at partners number four, Prosperity.com. And we’re happy to answer them. Super. Well, thanks so much to Kim Butler. This is No BS Money Guy Todd Strobel for the Prosperity Podcast. Say and take care, everybody. Thank you for listening to the Prosperity Podcast. To take control of your money and have it work for you. Visit us at partners for Prosperity.com.

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