THE BLOG
10/07/2014 12:05 pm ET Updated Dec 07, 2014

5 Steps to Loan Money to Your Kids and Actually Get Repaid

Over the last 30 years, I've met thousands of people. And I haven't met many who would deny their children if they were in need. As the father of three, I understand the sentiment. But as a professional, I can tell you that handing out support to your offspring can do a lot more harm than good sometimes. And I'm not just talking about writing out a check. If you loan your children money without them being serious about repaying you, the damage to both of you can be devastating.

You jeopardize your retirement and they get stuck in a vicious cycle of financial dependency. Most of the people I know who have loaned money to kids never see a dime in return. That's just sad for both parties.

Why not do you and your kids a huge favor and make sure this doesn't happen? Here are the five steps you can take to make sure your kids pay back any money they borrow from you.

1. Explain why you need the money back.
You may not want to share all your financial information with your kids and you don't have to. But they need to understand what your money means to you. Let me illustrate this point by sharing a story.

Rita received $1 million when her husband died 14 years ago. Her kids thought she was rich and didn't have any problem coming to her asking for loans. I understand her children. A million bucks sounded like a lot of money to them. Fortunately, Rita understood that it wasn't.

Rita's plan was to use that $1 million to supplement her retirement income. At 4 percent, she pulled out $40,000 a year from her nest egg. She explained to the kids that every dollar she loaned out was a dollar that would no longer provide income. Had she loaned out the $500,000 the kids wanted, her income would have been cut in half. If she did that she'd have no choice but to find a job and she didn't want to do that.

I'm not saying that Rita (or you) should never loan money to the kids. But you have to first understand what that capital means for your financial future. And your kids have to understand the meaning of that money as well.

2. Review their credit score.
Loaning serious money is a serious business. If this is money you depend on now or will depend on once you retire, you have to treat this as any business transaction. Before you agree to make the loan, have your kids share their credit score and history.

Review this information to get a sense of how reliable your children are when it comes to creditors. If there was a problem in the past, talk it over. Make sure the same behavior doesn't repeat itself.

If nothing else, this action will show your children how seriously you take the issue - and how seriously you want them to be as well.

3. See their plan.
Once you see their credit score and get a sense of how financially dependable they are, ask about their repayment plan. Of course you want to understand how much they are going to pay you on a monthly basis. But in addition, you want to see where the money is going to come from. Of course, this means you need to see their budget too. This will help you determine if the payment plan is doable or not.

4. Get a contract.
Your next step is to draft a simple loan agreement to include at a minimum the amount borrowed, the monthly payments, the interest, the length of the loan and the collateral if any.

You can either hire an attorney to draw this up or use a legal service to get it done inexpensively. I strongly advise against drawing up a document yourselves or following through with the transaction without having a written agreement.

The goal is to demonstrate to your children that you are serious about getting your money back and this is a key step you need to take in order to show that you mean business.

5. Put payments on Auto pay.
The last step is to get your kids to arrange for the loan payments to be made using Auto pay. This way the payment will automatically be made into your account each month without having to lift a finger.

This eliminates the awkward situation where you have to continually ask your kids for the payments they promised to make but don't.

I'm generally against loaning money to family - including the kids. Instead, I recommend they find other resources. But sometimes lending money to kids can be a win-win. At the very least, it doesn't have to be a lose-lose. Follow these steps.

Protect yourselves and your children. Make sure they only borrow money they can afford to repay and make sure they live up to their promises.

Have your children borrowed money from you? Did they repay it? Are there other steps we should take in order to make that happen?

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