Charging Your Parents Interest: Ethical?

An inquirer to the Christian Science Monitor’s financial blog “The Simple Dollar” poses this real life scenario:

“I’m 22 and have very robust finances…My dad recently suggested to me that instead of paying his credit card company interest (~20%, he thinks) on his balance (~$4000), I could lend them the money to pay it off in exchange for something like 10%….This is money I can afford to lose, and would otherwise be sitting in a money market or bond index fund. So my question: is it unethical to charge my parents interest, at least more than I’d earn otherwise? While 10% is much lower than their current payment, it’s much higher than I’d earn otherwise. If I’m willing to lend them the money at a lower rate, am I ethically obliged to?”

The Christian Science Monitor’s guest financial advisor, Trent Hamm’s answers: No, it’s not unethical, just unwise, because such situations often lead to family rifts.

He’s right about that, but it is definitely unethical to charge one’s parents high interest on a loan when the money would be earning less where it is now.Unless there is  family tradition of making kids pay the interest accrued on all the money their parents spent on them during their first eighteen years or so, an adult child charging anything but minimal interest on a moderate-sized loan to a financially strapped parent is ingratitude, pure and simple. Greedy too.

It is answers like Trent’s that make the public wonder what kind of ethics they teach in business school.

4 thoughts on “Charging Your Parents Interest: Ethical?

  1. It’s all subject to negotiations and family relationships. If the dad brought the issue up to his son, and suggested the terms, I think it’s perfectly fine for the son to accept or decline the terms without qualifying his response. If the father wanted to pay less, he would have suggested lower terms. If the son wanted to collect less, he would have asked his father to suggest lower terms. For all we know, the father’s true motivation was 2-fold. 1) He wanted to pay less, even though he could afford his current payments. 2) He wanted to enrich his son with money that would have otherwise been spent as he had planned.

    Lowering the terms arbitrarily without knowing the father’s intentions might insult him and be counter to his true motivations.

    • All true, although a financially clueless parent might suggest a figure that is higher than market, without knowing it. Sure, if a parent insists on paying extra, swell. Anything to make you happy, Dad. But you would be obligated to explain that he didn’t HAVE to pay a higher rate.

  2. And, lest you think that there is anything new under the sun, don’t forget Internal Revenue Code section 7872, which treats “gift loans” — and this sure sounds like it would fall within the statutory definition of that term — as if they had been made at standard market rates anyhow, for tax purposes. There are limitations to this treatment for “small” (less than $100,000) gift loans, but even they don’t apply if the transaction was tax-motivated.

    So not only is this setup ethically troublesome, but it may well reward you with some unexpected bills for income tax and gift tax.

    • (Warning: these are my own interpretations and I’m not a lawyer. Though I do feel like I have an excellent grasp on the subject.)

      Anyone can give anyone up to $13,000 a year without any income tax implications for the receiver or any gift tax implications for the giver.

      An amount less than $10,000 a year doesn’t even require paperwork to be submitted.

      Of course, if you are providing a loan, the interest you make on the loan is income and is reported as “interest income” much like you get from your bank annually for your savings account. (You do have a savings account, right?)

      Tax motivated loans typically come into play when loans generate income.

      In the article’s situation, providing the $4,000 loan interest free wouldn’t even raise a flag with the IRS. If the amount was over $13,000, they might take the liberty of computing the interest you should have been making and send you a bill for tax owed on the interest you should have been earning. By calling it a loan, setting a rate, and reporting the earnings as income, the actors in this scenario are in the clear from every perspective.

      Though, they should document the terms of the loan on paper officially.

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