Banking on mom and dad?

With traditional credit channels squeezed so much that even the bank of mom and dad is tightening its belt, social lending services have moved beyond typical peer-to-peer to target the inter-family space, as Ian Clover discovered.

“As the bank of mom and dad has become more stretched, the practice of simply gifting or lending unsecured finances to offspring has slowed. So where are young borrowers to turn now they are running out of credit channels?”

The end of a dream usually passes by undocumented, airbrushed from your subconscious by usurpation, or denied the chance to reach its natural conclusion by the aggressive interferences of alarm clocks, cat paws, partner's elbows or the intrusive beeping of reversing garbage trucks. We wake feeling unsatisfied, often eager to fall back to sleep in order to resurrect that ephemeral moment where it's you, yes you, receiving the quarterback's pass (the quarterback being the guy who serves you coffee every morning on the way to work for some reason, but still, it's your dream) and surging through to touch down to win the game. But by then the moment is lost. You can lay awake in bed and imagine how it might have played out, but it's never the same - once reality hits, there's nothing left to do but get on with your day and leave your dreams behind.

For millions of Americans, the end of their dreams is becoming increasingly manifested in realms that lie far outside the drool-stained comforter confines of their bedrooms. Their entire lives, previously spent pursuing their own versions of the 'American Dream', are now facing up to a harsh reality. Jobs are being cut everywhere you turn. Foreclosures and bankruptcies abound. Credit is tighter than an aging actress's botoxed forehead, and interest rates for those actually offered credit are often cripplingly high.

The Great Depression of the 1930s - while more dramatic and damaging in real terms than the one we are suffering through today - came on the back of relatively low-levels of prosperity, and went on to become the catalyst that propelled the US to the economic comfort it enjoyed throughout the prevailing six decades. During this unprecedented period of growth and affluence, income levels and living standards were raised to previously unimaginable heights - the baby boomers enjoyed privilege, education, luxuries, opportunities and a job market that delivered choice, growth, diversity, great salaries and, above all, stability. This was the American Dream in full flight. But as any First Grade science student knows, what goes up must come down, and it is inescapably obvious that we are now past the apex of prosperity, with the economic hardships coming our way threatening to be far more painful than those suffered by our 30s forefathers. After all, it is a hell of a long way to fall.

The children of the baby boomer generation have had it pretty easy so far. They were largely raised in safety, security and comfort. They were afforded sheltered, lengthy and lazy childhoods; white of teeth, tall of stature and encouraged to dream, to 'go one better' than their parents, just as their parents had done. This had become the standard starting point for the typical American family. A first car, a stolen kiss on prom night, a college education, a trip to Europe, a lasting career, a family and first house, good holidays and a healthy retirement fund. Now, the very fabric of this way of life is unravelling as property becomes prohibitively expensive, the threat of redundancy lays in wait in every industry, college funds decimate savings that have been eroded by emergency payments on mortgages and medical bills, and even the baby boomers themselves are losing their jobs and being forced to downsize both their dreams and their material extravagancies.

Bank of mom and dad

One telling bellwether of declining living standards and shakier economic stability is evident in the troubled times of one particular bank - the bank of mom and dad. For decades, this friendly and approachable institution has been dealing in the provision of low or no interest loans, and sometimes cash gifts, for young adults struggling with the economic pressures of life in the real world. Living standards that had become the norm for millions of young adults were artificially maintained with the assistance of pop's credit card or serendipitous and timely injections of fresh cash to cover car payments, rent, holidays, even deposits on a home. This easy credit channel was an indictment of the sound financial footing the baby boomer generation had forged for itself.

The fall of 2010 has seen a drastic contraction in the fortunes of the bank of mom and dad. Previously, financial pressures came solely from below, from offspring in need of a handout and a leg up, but today economic woe is hovering ominously overhead, too. For a number of mature workers, job stability is no longer what it was, with redundancies having struck a vast proportion of a section of the job market previously immune to minor upheavals in the economy. Such seismic shifts have had a deleterious impact upon the ability of mom and dad to pay their own bills, let alone the bills of their children, who now find they face a future fraught with insecurity, poorer prospects and harsher economic realities, as borne out by a swathe of telling data.

According to the Bureau of Labor Statistics, the unemployment rate for 16 to 29 year-olds in the USA in the first quarter of 2010 was 15.2 percent - the highest rate since 1948. During the same period there were 2.3 million unemployed college graduates, which is a massive 1.45 million more than in March 2007. The housing market has suffered just as much as the job market, with the rate of home ownership among those aged 25 to 29 falling to 37.7 percent in 2009, down from the pre-bust peak of 42 percent in 2006. As a result of the recession, traditional lending avenues are being squeezed, with 22 percent of adults aged between 18 and 34 being turned down for a mortgage, a loan or a credit card in the past 12 months, according to statistics revealed by FindLaw.com.

With youngsters struggling on all fronts, there has been a damaging knock-on effect on older age groups. At the very highest end of the age spectrum, the recession has resulted in an extra 500,000 over-65s (when compared to 2007 figures) being forced to continue working beyond retirement age, trapping the baby boomers in the middle. Merrill Lynch recently conducted a survey on the finances of wealthy households boasting more than $250,000 in invested assets and what it found was 36 percent of parents in this bracket were financially assisting at least one child, with another 45 percent supporting an elderly relative. But as the bank of mom and dad has become more and more stretched, the practice of simply gifting or lending unsecured finances to offspring has slowed. So where are young borrowers to turn now they are running out of credit channels?

Peer-to-peer lending

A few years ago there was a surge in the popularity of peer-to-peer lending services, fuelled largely by the proliferation of the Internet and the tumultuous period of growth and synergy that followed the dot.com boom. In recent years, peer-to-peer lending websites all but disappeared from view in the wake of easy credit and baby boomer-backed interfamilial support, yet there was always a market out there for this type of lending for those with nowhere else to turn. However, youngsters who had previously been able to rely on the assistance of the bank of mom and dad had little need for these services. But with the current economic climate dictating proceedings, even lending and borrowing between families, if it is to happen at all, is beginning to see the value in calling upon the services of an independent ombudsman to adjudicate proceedings.

One such 'independent' is Virgin Money US. Their website homepage opens with a faintly unnerving 'We've Been Expecting You' banner headline. This faux-pally welcome is all par for the course for a company as customer-savvy as Virgin, but it is the message itself that sticks in the craw. At once friendly but also presumptuous, it says your custom is welcomed, but also expected. There is a hint of smug knowingness in its tone. There is the knowledge that, for millions of Americans, they have little alternative but to turn to Virgin Money to help them out of a sticky situation.

The service offered by Virgin Money is very simple. For a small fee, it mediates loans made between two known parties, allowing family and friends to formalize the loans they make to one another. Lendfriend, a growing start-up that creates and establishes pre-agreed repayment programs and schedules, and also enables electronic payments and collections between parties, offers another similar service.

Essentially, sites such as Virgin Money and Lendfriend remove the pain and awkwardness that can often result from lending to loved ones by implementing a set of rules and regulations similar to those that a normal bank or creditor would impose. Peace of mind follows; fractious relationships, hopefully, do not.

"Lendfriend assists during the entire life of a loan, through the creation, proposal, approval and repayment stages," says Dave Kuchar, CTO of Lendfriend. "We partner with PayPal to manage the loan payments and focus solely on friends and family with pre-existing relationships, so rather than focusing on creating a relationship between people, we are basically focusing on not screwing them up!"

This peer-to-peer lending model appears to be working. In the last six months of 2010, Virgin Money experienced a growth of 35 percent in loan volumes, which also indicates the growing demand for the service. While a parent helping out their kids financially is nothing new, the industry's growth is one indication that the bank of mom and dad has suddenly gotten cold feet. A survey by CreditCards.com earlier this year revealed that parents are still keen to help out wherever they can, with 40 percent of those polled admitting to paying off a child's car loan, 37 percent settling medical bills, 31 percent repaying utility bills and 30 percent interjecting on credit card payments. But parents have become wearier than ever in the wake of their own job insecurities, rising interest rates and shakier financial footing.

While the current economic situation has undoubtedly boosted the popularity of peer-to-peer lending sites - especially those based around pre-existing relationships - Kuchar believes that more sophisticated technology and marketing techniques have been equally instrumental in supporting this fledgling market.

"From what we understand, people have always conducted this pattern of lending," says Kuchar. "There have always been people who, for one reason or another, have been turned down by a bank and so have turned to family or friends for support. So we are seeing a lot of people starting to use our service because they are just starting to hear about it. It has only been in the last two years that such personal financial tools have become available and known about, so to our customers it makes sense to use us rather than go off the books."

By building upon established emotional connections and trust, Lendfriend is free to focus solely on utilizing its technology to prepare, mediate and resolve its loan arrangements, using smooth and sophisticated software to ensure transparency, accuracy and fairness for both parties.

"We are basically a software service," Kuchar says. "Our main goal is to protect the relationship from the stress that invariably comes from managing money. This is achieved via step-by-step guidance through the loan. So at any point we provide a task list of what's next, what's been paid etc. We send e-mail reminders and constantly keep pinging both parties back and forth so they know what to do. And we keep the process very formal."

Lendfriend provides an official, electronic record of the loan whereby both parties can log into their account and view its progress. "Promissory notes and agreed terms are always visible, and all payments through PayPal are fully recorded. The loan parties can record whether or not they forgave a loan payment, which is optional. Parties are also free to make off-schedule payments, larger payments and even late payments - our software can recalculate all eventualities, which adds flexibility to the customer," says Kuchar.

With a loan agreement mediated by Lendfriend fully and officially 'on the books', parties are also protected by, and subjected to, the standard credit procedures and legalities they would be had they gone through the more traditional channels for credit and borrowing. "From a legal standpoint," reveals Kuchar, "we suggest that the lender make a promissory note on their behalf, and secure the loan with some collateral, and even though it is lending between friends and family, we will be adding credit scores and credit reporting in 2011."

This service will be optional: if the two parties do not know each other very well (or perhaps they know each other too well), they can agree on the level of credit visibility prior to arranging the loan. "This is an online negotiation they can have," says Kuchar. "Similar to the way a lender and borrower can draft the loan proposal between them, deciding on payment terms and dates for example, they can also negotiate upon credit reporting. We will be working with the credit agencies, so using Lendfriend can actually help improve, or indeed damage, one's credit score."

For lenders who use Virgin Money and Lendfriend, there is always the potential danger that they are lending to individuals who were unable to obtain money through conventional channels, and there is almost always a reason for this. Having said that, with fewer credit options available, perhaps the sober visage of an expectant friend or family member, eager to know when the next repayment will be made, will encourage many of America's youth to become more financially responsible, more quickly.

If your offspring are still too reliant on you for support, FST suggests a few tips on how you can help them become financially independent without sinking into debt.

Can you afford to loan? You shouldn't be loaning any money if it means you are putting your own finances in jeopardy. Even if lending to a child or fellow loved one, be prepared for the worst-case scenario - that they might not pay you back. Ever. Assess whether you can fully write off the sum. If not, it may be more helpful in the long run to work with your child to find another solution to their problem.

Draw up a loan agreement. Before proceeding with a loan, you should ensure you have drawn up a formal agreement. You should detail all terms - the amount borrowed, any interest, payment terms - and note down how the money will be paid back, with an acknowledgement that receipts will be issued and delays will not be tolerated. You could even make provisions for penalties if you are feeling particularly hard-nosed. This is where sites such as Lendfriend and Virgin Money can prove particularly useful.

Never give handouts. Paying for college is one thing. Maybe covering a couple of credit card bills once they've graduated is also permissible. But by simply giving into demands for cash handouts, you are sending out a dangerous message. Let your adult children know that you will support them in other ways, but financial bailouts are, post-college, off limits. They might not like it at first, but will soon appreciate your stance, become more self-confident and grow into financially savvy individuals.

Don't be afraid to say 'no'. The sooner young adults get used to hearing this, the sooner they will start taking greater responsibility for their actions. But be fair, too - if you can see that their predicament can be eased by the careful provision of a loan, proceed. You can then teach them a valuable lesson without resorting to preaching or moralizing, which is something they certainly won't thank you for.