Yesterday I told you the story of when I borrowed money from my parents and how it really bothered me. I don’t think I could ever utilize my parents as my mortgage lender but as credit markets continue to tighten, more and more people are heading for the Bank of Mom and Dad for their own personalized mortgage deal.

Family mortgages

Family mortgages can work as long as everyone fulfills their end of the bargain, timely payments are made, and the taxes and insurance premiums are paid. When you consider the minuscule returns on “safe” investments such as certificates of deposit or money market accounts, getting a 5% return on a mortgage backed by real estate can be appealing. Additionally, when you combine these type returns with the tight lending standards many young home buyers are facing, you begin to realize that there’s a need and a way to fill it. With many Baby Boomers now unwilling to risk their life savings in the stock market, financing a child or other family member’s mortgage could be an opportunity for a win-win situation.

I personally have some friends who, though the creation of a family trust, are able to offer mortgages to family members. They operate via a committee of 6 or 7 people who evaluate each applicant and then make a determination whether to offer a mortgage and how much. The original money came from the sale of a large business that a great-grandfather had started back in the 30′s. That money he made is still helping his family today. Great legacy, huh?

The roll of the IRS

Parents who finance a child’s home purchase can easily find their generosity in conflict with the mission of the Internal Revenue Service. Some of the possible problems:

A mortgage with far too generous terms

If the interest rate is less than the government’s applicable federal rate at the time of the loan, the IRS may want to have a meeting. Those rates apply only for loans of a certain duration (such as ten years) so it’s best to run anything like this by your accountant or tax advisor.

Gift Taxes

Gift taxes were instituted to prevent the wealthy from giving away their fortunes before they died. If a parent is thought to have gifted the mortgage proceeds, the IRS won’t be happy. It’s best to keep all paperwork handy and to insure that the mortgage really is a mortgage and is being repaid.

The potential for missed tax deductions

Anyone using the Bank of Mom and Dad for a mortgage should make certain their mortgage is registered with a government authority and filed at the courthouse in their county or parish. Non-registered mortgages are not eligible for the interest deductions and subsequent tax breaks that a regular mortgage is so register that mortgage! A reputable attorney should be able to help you complete this step.

The risks of a family mortgage

Obviously the biggest risk is of default and that’s a huge concern for parents. Many times one parent will be gung-ho and the other … not so much. The concern is that a parent will fund a mortgage only to have to eventually evict their own child or risk losing their life’s savings. That isn’t a fun thing to have to consider as a parent.

Another risk is the loss of financial flexibility for the parent. A mortgage isn’t exactly a liquid investment and should another more profitable or more appealing investment opportunity come along, the parent is generally stuck.

What about you? Would you consider lending your child $250,000 for a mortgage or even $50,000 for their down payment? Would you consider borrowing that amount from YOUR parents? I wouldn’t want to be on either end of that deal, but for many people a family mortgage is just the ticket to get Mom and Dad a reasonable rate of return and to get Junior into that house.

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Have you ever borrowed money from your parents?

Speaking from my experience, borrowing at the Bank of Mom and Dad isn’t always a pleasant thing. Approximately 15 years ago I was promoted to a management position on the East Coast. My company’s moving policy was – “move yourself, submit your expenses, we will reimburse you, maybe.” That weeded out a lot of tire-kickers but probably weeded out a lot of really good managers as well. Despite the shortsightedness of such an asinine policy for a multi-billion dollar company to arbitrarily use, I decided that a lack of money wasn’t going to stand in my way of success.

So I asked my Dad for $1,200. I was in the throes of financial stupidity and had no emergency fund, no budget, no savings account, no spare cash of any sort. My credit cards were maxed out and delinquent. I was behind on my student loans, behind on hospital bills, and behind on anything that required a payment … except rent and utilities. That $1,200 was just barely enough to rent a U-Haul, make my first month’s rent payment, and make the deposits for my utilities on my newly rented condo. But that was all.

Thankfully, my Dad said yes, despite the misgivings of my Mom. She wasn’t happy that we were moving her grandchildren 12 hours away and that $1,200 was enabling me to do exactly that. It was an emotional meeting we had that day and things only went downhill from there.

I had never officially borrowed money from my Dad and as a grown man of 30 years of age at the time, it gnawed at me. Voices inside my head kept repeating: “You aren’t able to take care of your own family without help. What kind of man are you?” I was in even more debt now and it truly bothered me. That loan was something that hung over my head every single day and my Mom’s dunning me wasn’t helping either. Even though the company didn’t reimburse me fully, after only 45 days, I was able to pay my father back with my monthly bonus in my new position (it paid substantially better than my previous position). My wife and I eventually moved back closer to my parents, thanks in large part to the experience I was able to garner as that store manager.

I haven’t borrowed from my parents since.

Back in 1996 peer-to-peer lending companies like Prosper and Lending Club weren’t around. I wish they had been. I would rather have borrowed from a stranger than have to stare at my family across the Thanksgiving dinner table knowing I owed them.

If you find yourself needing some cash, why not consider a peer-to-peer lending company like Prosper or Lending Club? Both have interest rates and terms that will let you keep your dignity and prevent that Thanksgiving turkey from tasting a little strange. I dunno, maybe it’s the canned cranberry sauce?

On the other side of the coin, if friends or family ever come to me wanting to borrow cash, my plan is to direct them to Prosper or Lending Club and then help fund their loan myself. I believe that’s the best way to maintain a good relationship as well as keep money from causing hurt feelings and bitterness.

What about you? Have you ever borrowed from friends or family? Have friends or family asked to borrow from you? How did it work out? How did you feel about it?

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Having children is one of my life’s greatest events. But few great events come without a price tag and in the case of children, the financial shocks that new parents experience are strong. According to the US Department of Agriculture, a middle class family will spend $250,000 to raise a child from birth to age 17. Now if you’re like me and wondering why the Department of Agriculture is commissioning a study on the costs of child rearing, bear in mind that figure doesn’t include college expenses and probably doesn’t include the cost of cell phone data plans, car insurance, cars, wrecked cars, homecoming dresses, etc, etc, etc!

Though most people are first shocked by the lack of sleep and pure exhaustion, the first year’s financial shocks to their budget are just around the corner with some estimates in excess of $12,000. Our first child came as a complete surprise to my wife and me and then our second surprised us even more when she showed up just 12 months and three weeks later! I was COMPLETELY unprepared for either of them from a financial standpoint (and most other standpoints as well), but somehow we made it. I only WISH I had been smart enough to even marginally prepare financially for our three children.

What are the financial shocks that I experienced? What financial shocks will new parents experience at the birth of a child?

Financial Shocks for New Parents

1. Medical expenses
2. Maternity leave
3. Life insurance
4. Diapers and wipes
5. Formula and breast feeding
6. Baby food
7. Clothing
8. Gear
9. Child care

Medical expenses

Our first child was relatively easy on us financially (that first year). Easy delivery, no health problems, and the standard doctor’s checkups. Still, she wasn’t cheap even with my very good health insurance coverage. Our second child was a different story and she required home health care … and we had changed insurance … to one that wasn’t quite so good.

Delivering a newborn can cost anywhere from $5,000 to $15,000 and depending on your medical insurance and your deductible, you could be faced with paying a large portion of it. My advice is to budget NOW for the expenses you know you’ll incur.

Preparation: Contact your insurer or the benefits director at your work to make certain you understand what is and isn’t covered then set up a savings account and make regular deposits into it. You won’t regret it.

Check out the best budgeting software on the Internet! YNAB – You Need A Budget

Maternity leave

Many companies offer a short-term disability insurance policy to cover the time Mom is out of work to have a baby or for any complications during pregnancy. Still, the average policy only pays a fraction of Mom’s gross income and then only for four to eight weeks after the birth (policies vary so be sure and check). For a maternity leave beyond the set time, or if Mom or Dad decides to take advantage of the Family and Medical Leave Act (FMLA), it will be at zero pay unless you use vacation or sick leave.

Preparation: Try living on one income for several months prior to your child’s birth.

Life insurance

You should consider increasing your life insurance prior to the birth so that each spouse will be financially able to raise the child through the college years. Go with a level term policy that is convertible to permanent at some point in the future.

Preparation: check out GoInsuranceRates.com to get a quote from a top rated insurer.

Diapers and wipes

Whether you use disposable diapers or cloth, they’re not free. The average baby goes through 10 to 12 diapers each day and if you use disposable wipes, count on spending a minimum of $100 per month to keep that little bottom clean. If you plan to use a cloth diaper service, you may make out a little cheaper but it has its own drawbacks. Be careful what you believe, both have their advantages and proponents (and lobbies and websites and assertions).

Preparation: do your own investigation. Ask friends which system they preferred and don’t be swayed by rabid proponents either way, and possibly consider laundering your own. That will save a lot of cash.

Formula and breast feeding

Formula can be a big shock. A general rule of thumb is that a baby needs 2.5 ounces of formula per day per pound of body weight. While breastfeeding can certainly minimize that expense, it isn’t as free as you may think. There are breast pumps, lanolin ointments, nursing garments, and breast feeding pillows to add to your expenses.

Preparation: find out how much savings you could realize by breastfeeding and then shop hard to find the best prices.

Baby food and cereals

Once your newborn reaches four to six months, he or she will begin to want more solid food and cereals (just wait til they’re teenagers!). Baby foods can get expensive so consider making your own by pureeing fresh steamed organic carrots, broccoli, or other vegetables.

Preparation: invest in a quality baby food maker and learn to make your own baby food.

Clothing

The cost of children’s clothing is ridiculous, rivaling the cost of adult clothing ($34.99 for baby Nike’s?). Babies grow so quickly that they need new clothing regularly and even when friends give you clothing as gifts, many times your child has outgrown them by the time the season is right!

Preparation: shop at consignment shops and yard sales and remember: since children outgrow their clothes so fast, it doesn’t make sense to splurge on the latest fashions.

Portable gear

The amount of gear babies need will blow your mind. Strollers, car seats, toys, swings, monitors, bouncy seats, changing tables, cribs, baby beds, cradles, pacifiers, bottles, plates, bowls, sippy cups, high chairs, bibs, bathtub seats, safety supplies, blankets, sheets, and of course, the giant backpack (or little red wagon) to haul it all around.

Preparation: don’t be afraid to have second-hand gear. Shop at yard sales, consignment shops, and thrift stores to find some great deals. Also network with other parents or family to use gear they no longer need or use.

Child care

If both parents work, or plan to, they better be prepared for one of the largest financial shocks associated with having a child – child care. Paying someone to care for your child can cost anywhere from $5,000 per year for a family day care center to $20,000+ for a live out nanny (and don’t dare forget the taxes). My wife quit work 18 years ago when our first daughter was born so we didn’t have this shock, but we did have the shock of losing her salary.

Preparation: investigate the childcare options available in your city and decide which one meets your needs and values. Be sure to evaluate whether you or your spouse’s income will be vaporized by childcare, work clothes, transportation costs, meals, and other items associated with having a job.

No one is ever really prepared … you can’t be

Sure, maybe a lottery winner is prepared, but for rest of us having a baby has its own financial shocks. The fact is that few families begin thinking seriously about the money a child requires until after they become parents, so you are not alone if you haven’t considered these types of expenses.

But … you are in a LOT better shape than I was. You know what to expect and if you’re willing to follow the preparation recommendations above, you’ll be miles ahead of other newborn parents.

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I was recently asked by an email reader named Susan about how to handle the needs of her own retirement in light of her kid’s needs AND her parent’s needs for financial support.

I honestly never expected my parents to live as long as they have … and they didn’t either. Today I and my husband part of the “Sandwich Generation” — squeezed between our own savings for retirement, my elderly parent’s need for financial support (his parents passed away 14 years ago), and my two boys needs while they’re in college (one is 19 and the other is 21). Which of these three demands should take priority?

Note: This is an increasingly common problem, one exacerbated by a lack of good financial planning on the part of her parents and by the ever escalating demands and expectations that parents should foot every bill a child incurs until the age of 26, or 30, or even older.

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Here is my advice: Your parents need food, water, shelter, and probably health care. If they can’t meet those needs on their own, then Susan, you and your husband, along with any of your siblings, are going to have to help them. It won’t be easy. One sibling may not agree or my contribute less than another, despite earning more. One sibling may feel he or she “cares more” and spends more time taking care of your parents. One may want to send them to an assisted living facility and another may not. Regardless, there will be disagreements, so FIRST sit down and outline on paper what you all can … and will … do from this point forward, as well as plans for all contingencies you can think of like:

• A sibling or their spouse losing a job
• One parent passing away
• One sibling or their spouse passing away (consider life insurance)
• Who will handle your parent’s finances and how will they be audited (for lack of a better term)?
• Reluctance on your parent’s part in accepting financial help despite needing it
• How to handle the sale of any parental assets including their home

If your parents DO own any non-performing assets such as a large home or two vehicles, those should possibly be sold or downsized. Also, any cash sitting idle in a bank account or any other financial assets may have to be liquidated to pay for your parent’s needs. And don’t forget that if you can afford it, you can give them up to $13,000 in cash or property each year without having to worry about the tax implications.

Once you have your mother and father taken care of, your next priority should be your own retirement funding.

The needs of your children must come in third in this personal finance triage. Why? Kids can always get scholarships, grants or borrow for their college education. There are no scholarships for retirement and the last time I checked, there wasn’t a retirement loan program either.

Don’t think of this as being selfish. Think instead: Do YOU want YOUR kids to have to take care of YOU like you’re having to take care of YOUR parents today? I’m guessing no. Putting your own retirement needs ahead of your kid’s demands for more cash from the Bank of Mom and Dad will actually benefit them in the long run. When they’re your age, they won’t be faced with the same dilemma you’re facing. Chances are they won’t understand, but that’s part of being a parent — seeing a bigger picture and having the wherewithal to put it into place amidst a flurry of protests and emotional threats and guilt trips.

Also, don’t forget that if you ARE taking care of your parents financially and are providing more than 50% of their support, you may be able to claim them as dependents on your tax return — even if they don’t live with you! (check with your tax advisor)

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Back when I was 17 (in 1983), I spent the summer in Guatemala working with a missionary. One of the perks of such a trip was that I would occasionally have a few days to explore the countryside and on one of my excursions, I found myself in Antigua, the old capital. It was spectacular, with its ruins, old colonial churches, street vendors, and beautiful city square. It was there that I met the hordes of locals vying to be my “guia” or guide to the city. Having spent two years studying the Spanish language and discovering that few families conjugate verbs around the dinner table, I was thrilled when one man strode to the front of the group and introduced himself in near perfect English.

“My name is Ramon, sir, and of all the excellent guides here, I alone can speak to you in your native tongue.” He certainly had my attention. My first thought was, do I look that obvious? He went on to explain that he would guide me around the city, showing me its secrets and at the end of the 2 hour tour, I could pay him whatever I thought reasonable. Sounded good to me! I took him up on his offer and we began a great city tour, seeing the monasteries, the convents, and the beautiful Mudejar-influenced Baroque style architecture.

After about two hours, he said, “This is the end of my tour. If you enjoyed yourself, you can pay me whatever you think my services were worth.” I really did enjoy myself and after checking with my host who had accompanied me, I decided to pay him $6 (US). That was a LOT of money in the central Guatemalan highlands in 1983 for two hours of work! But when I looked in my wallet, all I had were twenties. He didn’t appear to be the sort that carried change and the embarrassment of trying to find someone to break a twenty wasn’t anything I looked forward to, so … I just gave him a $20.

He was stunned.

He started jabbering in Spanish and for a moment I thought I had broken some rule of etiquette and embarrassed HIM. He regained his composure (as did my host) and in a quivering voice said to me, “Sir, you are so generous. No one has ever been this generous to me, may I show you more of the city? This time I will give you the good tour!” He became very friendly and was obviously happy with the amount. It wasn’t as though I didn’t want to give it and honestly, I liked the guy. Having heard him speak of his family, I felt somewhat like I was helping a friend.

Yet, in another way, I felt like I was paying someone to be my friend and it made me feel a little cheap … event thought the amount was considered substantial. Was the friendship we’d developed real or merely financial? Could it be both?

I ask myself these types of questions every time I see a tip jar sitting on a table, next to a cash register, or on the shelf at the drive thru window at Starbucks. I’m a generous tipper, having lived on tips while working as a waiter after college. I don’t mind tipping someone and I even tip well when the service isn’t that great. It drives my wife crazy.

Tipping doesn’t bother me. What DOES bother me is that even though I formerly worked for tips, I really don’t understand what’s being bought or sold. Is a tip a wage? A gift? Charity? I’m not talking about the tax implications, I’m talking about the social implications. What IS a tip?

The most common explanation is that a tip is a reward for good service, even though it’s commonly thought that TIPS was an acronym for To Insure Prompt Service. It doesn’t matter. Research doesn’t bear this out! Most research I’ve seen shows that the correlation between service and the size of the tip is weak at best. So why do tips exist? Why do servers in US restaurants receive over $44 BILLION in tips?

Most research that I’ve read confirms that tipping began as a reward, but quickly became a social norm. Most people today tip because they want to

• Show gratitude
• Conform to societal norms
• Help supplement a server’s low income

Why would people want to supplement a server’s income? Probably because it’s human nature to feel anxiety or stress when we perceive an unequal relationship with another person. Tipping restores that balance in our minds. With a society considered to be extroverted (United States) or with significant status differences (India), or more masculine in nature (Mexico), tipping tends to occur more often, to a wider variety of positions, and in great amounts than societies that place high value on equality (New Zealand) or that emphasize social relationships over economic ones (Japan).

Did you know:

• In Bangladesh, restaurant tipping rates are only 5 percent?
• In Japan, tips could be considered insulting?
• In Paraguay, tip is the same word as bribe (propina)?
• In Hungary, it’s customary to tip your doctor?

Have you ever seen a couple get their check at a restaurant, leave some money on the table and quickly leave? If that happened in the US, chances are good that they were embarrassed at the size of the tip … and not because it was so large. On the other hand, if you were in the United Kingdom, the English don’t like to make a big show so they’ll typically round up the bill and leave it on the table.

Emotions certainly DID steer my decision to tip my guide that July day in Guatemala. I had made a friend and I didn’t want to embarrass him or me by looking like a cheap wad who wanted his change.

Have emotions ever driven your tipping decisions?

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