It doesn’t matter whether your kids are school-aged or fully grown adults – if they’re in trouble, you’ve got their backs. However, if your children have made poor financial choices and need help paying off massive debts, you may question whether you should step in and help.
Although it’s not necessarily your responsibility to fix your kids’ financial messes, you realize the impact that debt can have on their future. Too much of it can lower their credit scores, limit their ability to get a home mortgage or auto loan, and may even impact their employment prospects. Writing a check and clearing your children’s debts can certainly lift a heavy burden, but it may not be the best move. There are both pros and cons of taking this action, so it is best to take your time, weigh both options, and come to a decision that you feel will be best for you and your child’s unique situation.
Advantages of Paying Off Your Children’s Debt
1. Give Your Children a Fresh Start
Many young adults get their first credit card while in college. This provides an opportunity for them to establish a credit history at an early age. However, the responsibility of managing a credit card can be too much for some students. Between poor budgeting and overspending, some end up with maxed out accounts.
Paying off such a debt can give your children a fresh start. However, along with financial help, they need to be educated on the right and wrong ways to manage credit and money – or else they may find themselves in the same situation all over again.
Here’s how you can help give your kids a clean slate:
- Review Monthly Expenses and Income. There are several budgeting apps available, such as Mint and MoneyWise, that may prove to be very helpful. Or, if you prefer, you can teach your kids how to create a personal budget the old-fashioned way: with a pen and notepad. They need to list and calculate all their fixed monthly expenditures (such as transportation, housing, and utilities), and then subtract this total from their net income. “Budgeting” might sound like an ugly word because it implies frugality and financial limitations, but it can help your kids see exactly where their money goes each month, and help them assess whether they’re living within their means.
- Trim Monthly Expenses. Your children are on the right track if their monthly expenses are lower than their monthly income. However, if they’re spending more than they’re bringing in, work with them to trim costs. For example, you may suggest taking public transportation to reduce fuel costs, clipping coupons to save money on groceries, cooking meals at home, shopping at secondhand stores, or finding a cheaper place to live.
- Create a Monthly Spending Plan. Help your children create a spending plan for each month. This establishes how much they can spend in specific areas based on their disposable income, which are any funds remaining after they pay their bills. For example, based on your children’s income, they may only be able to spend $50 per month on recreation and $150 per month on food. Suggest the envelope budgeting system to help your kids stay on budget. Have envelopes for various spending categories – entertainment, grocery shopping, gas – and store a specific amount of cash in each one on a weekly or monthly basis. For each category, only spend what’s inside the envelope and nothing more.
- Provide Credit Knowledge. Credit cards are useful, if used responsibly. After paying off the debt, sit down with your children and discuss good credit habits. If you don’t know much about credit yourself, go online and research the topic. Encourage your kids to only charge what they can afford and to pay off balances in full each month to avoid debt and interest charges. Make sure they understand the importance of timely payments, and suggest paying credit card bills as soon as they arrive in the mail, or creating a reminder on their cellphone or computer. Also, encourage them to obtain a free credit report at least once per year.
2. Protect Your Personal Credit Score
To help your children establish a credit history, you may have cosigned a loan or credit card. This was a nice gesture; however, cosigning has its risks. Although you’re not the primary account holder, any activity associated with this account shows on your credit reports, including late payments and balances. Additionally, you’re responsible for this debt if your children don’t pay.
Cosigning works if the primary account holder makes each and every payment. However, if a payment is skipped (or they’re stopped altogether), it could appear on your credit file. This negative activity can remain on your credit for up to seven years and reduce your score. And, since you’re liable for this debt, the creditor will contact you for payment.
If you cosigned a loan but your child can no longer afford the payments, repaying this debt is the only way to protect your score and avoid problems with creditors, such as judgments, collection accounts, and lawsuits. However, don’t just pay the debt and move on. Think of it as a loan, and only help if your child agrees to repay the money:
- Establish Payment Arrangements. Determine how much your child can repay, whether it’s the entire amount or only a portion. Next, decide how long to spread out the payments – perhaps 12, 24, or 36 months, based on what’s feasible. If you choose to charge interest, decide how much. You can charge a rate comparable to many bank loans, or slightly lower. Use an online loan calculator to compute monthly payments based on the amount, term, and interest rate.
- Get the Agreement in Writing. A formal written agreement between you and your children highlighting all of the aforementioned terms can alleviate any wrong ideas. For example, you may pay off a debt under the assumption that your children will repay the money, but they may view your gesture as a gift. This potential misunderstanding can be easily avoided by putting your expectations in writing. After your kids read the agreement, you both need to sign the contract and retain copies for your individual records.
3. Help Your Children’s Credit Score
Since the amount owed to creditors makes up 30% of credit scores, too much debt can lower your children’s score significantly. A low credit score makes it harder for them to get a mortgage, auto loan, and other types of financing. Additionally, a low rating may result in higher insurance premiums. However, if you pay off all or some of the debt, this reduces how much they owe, which helps increase their credit score.
4. Protect Your Relationship With Your Children
It’s not your obligation to pay off your children’s debts. However, refusing to help can potentially strain your relationship, especially if they feel hurt or abandoned.
On the other hand, offering assistance demonstrates your support. Even if you’re financially unable to write a check, you can provide reassurance and perhaps work with your kids to create a debt strategy.
Disadvantages of Paying Off the Debt
1. They Don’t Have to Accept Responsibility
Paying off your children’s debts can potentially stop collection calls and prevent credit damage. However, unless you require your kids to pay the money back, they don’t accept full responsibility for their actions, nor do they experience the full consequences of their poor choices. Understandably, you want to shield your children from these consequences – but if they’re not accountable for their bad decisions, or required to deal with the repercussions, they may repeat past mistakes.
By dealing with debt themselves, your children are forced to put on their “problem-solving” hats and come up with a realistic debt elimination strategy. This may involve doing research online or speaking with a credit or debt counselor. If you choose not to pay their debt, your kids may learn useful techniques, such as budgeting, reducing expenditures, negotiating a lower interest rate, and transferring balances. Additionally, stepping back can teach your children financial patience. In other words, they can learn that every money-related goal takes time, and they can’t always run to mom and dad for help.
2. It Can Compromise Your Finances
In your crusade to protect your children’s finances, you could end up damaging your own. Taking money out of your personal savings account or emergency fund might significantly reduce your cushion, which can make it harder to get through your own financial hardships that may arise in the future, such as a sudden job loss, a major home repair, or an illness.
If you have a 401k, an IRA, or another retirement savings account, you might be thinking about making an early withdrawal to help pay off the debt. Under no circumstances should you take money out of these accounts – taxes and penalties are applied to early withdrawals. Plus, you reduce your growth potential, which can impact your financial security after retiring.
Helping your children pay off a debt can also take money out of your household each month. This may not be a big issue if you have a good amount of disposable income. However, if you’re barely making ends meet, you might have trouble paying your own bills (mortgage, utilities, credit cards, and loans). This can result in late payments and a damaged credit score, and even possible resentment toward your children or other relationship issues.
3. It Can Trigger Problems With Your Spouse
Don’t agree to pay your children’s debt without first discussing it with your spouse. The two of you may have different opinions regarding the best way to handle the situation. You may be eager and ready to help, yet your spouse may feel that it’s your kids’ sole responsibility to deal with balances.
To maintain the peace, it’s important that you’re both on the same page. Consider the aforementioned pros and cons, and then decide on the right move. And whatever you do, be honest and don’t let the debt divide your relationship. If you go behind your spouse’s back and make a decision on your own, it can create tension in your household.
In the end, only you can decide whether to pay off your children’s debt. If they are remorseful and fully comprehend the seriousness of the situation, or if circumstances beyond their control played a role in accumulating the balances, such as a job loss, illness, or divorce, then lending a hand can help get their finances back on track. However, if your children have a pattern of irresponsible behavior, or don’t show any regret over this experience, it’s probably best to step aside and let them figure it out on their own.
Do you think parents should help pay their children’s debt?