Your children ask to BORROW money.

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Author: Esswein, Pat Mertz

FLASH POINT: The kids want to buy a house but don't have the cash for a down payment. They come to you.

SHAKESPEARE'S injunction to "neither a borrower nor a lender be" is never more appropriate than when it comes to lending kids money to buy a house. Giving them the money outright could be even worse, if it depletes your savings.

Advancing cash for a down payment helps first-time buyers get a foot in the door and represents an investment in your children. "You hope the kids will one day think. The folks were there for us, so we'll be there for them," says Beth Mabry, a sociologist at Indiana University of Pennsylvania.

But there's a steep downside for both parties. If you're the adult child, taking money from your parents may mean you sacrifice some of your independence. Your parents could exercise a veto over the cost and size of your house. And--surprise!--they may expect you to pay the money back.

If you're the parent, making a loan or gift to one child may ruffle the feathers of his or her siblings. Are you prepared to set a family precedent? What if you have misgivings about your child's spouse or the state of the marriage? And what if you want--or need--the money back? Remember that other famous caveat about making a loan: Don't lend money you can't afford to lose.

If you're still open to providing financial help, you need to lay out your expectations. "It pays to be frank and have the uncomfortable conversation up front," says Steve Blankenship, a financial planner in Dallas.

That was the case with Angie Missal, 28, a third-grade teacher in Port Orange, Fla., and her paternal grandparents, Bernie and Donna. The elder Missals lent their granddaughter $28,000 for a down payment on a $140,000 house near their home. "They were clear about what they were willing to provide and I jumped on it," says Angie. "As an adult, I would never have expected them to give me that much money."

Angie repays her grandparents $ 150 a month. "We didn't want it to be onerous, considering her salary and her mortgage payment, but we wanted to teach her financial responsibility," says her grandfather. The family agreed to revisit the arrangement after several years to consider the possibility that the elder Missals would zero out the loan balance as a gift to Angie.

If you lend your children money, the IRS requires that you charge a minimum interest rate--3% to 5%, depending on the term--for the transaction to be considered a bona fide loan. Set the rate too low, and the IRS may consider the difference an indirect gift, with possible gift-tax consequences.

In 2000, when Anne Greene, 35, wanted to buy her first house, in Boulder, Colo., she asked her parents for $40,000. They offered to lend her the money at 6% (compared with the 8% rate on her mortgage). Greene eventually refinanced her mortgage at 4%. With interest rates falling, her parents got an attractive return on their money, which Greene eventually repaid.

To ensure that the borrower can deduct the interest, and to protect your investment in case of default, the loan must be secured by a lien on the property. That means you have to document the transaction with a promissory note and officially record it with the appropriate agency. CircleLending.com can help with the paperwork, set up a repayment plan (a sticky wicket for families), and even report a private loan to credit bureaus so the borrower has a credit history.

If you don't want or need repayment, and you're looking for ways to reduce your taxable estate, you can give your child $11,000 a year without incurring the gift tax. If your spouse joins in the gift, that's $22,000--or a total of $44,000 if you each make a gift to your adult child and his or her spouse. If your gift exceeds the annual exclusion, you'll have to file a gift-tax return (Form 709), and the excess will count against your lifetime gift-tax exclusion of $1.5 million.