NEW YORK (Dow Jones)--The couple called their financial advisor, Kathleen
Kuehl, on a Monday morning. They needed help, fast.  They had just learned their 30-something son had three days to pay $25,000 in cash to his soon-to-be second ex-wife under a divorce settlement. He didn't have the money. The parents wanted to help, but not too much.

"They didn't want him to think that if something like this happens again, 'I can just run to mom and dad and they'll bail me out,'" said Kuehl, a financial principal at Lowry Hill, a wealth management unit of Wells Fargo & Co. (WFC).  And with the clock ticking, "there was no way he was going to secure a loan from a commercial institution in the time frame he needed it."

Kuehl solved the problem by structuring an "intra-family" loan from the parents to their son. He got the money in time to satisfy the judge's deadline - along with a five-year schedule of payments back to his parents, including interest, that would be deducted directly from his checking account.

Financial advisors may be spending more time working with the "Bank of Mom and Dad." Baby boomer clients interested in helping their children buy homes, start businesses or deal with life crises like divorce can use these intra-family loans without cracking their own retirement nest eggs. For the younger generation, facing high real-estate prices and saddled, perhaps, with student-loan and credit-card debt, these loans are a way to borrow money onfriendly terms.

The interest-bearing loans - formalized with promissory notes and fixed repayment schedules - allow parents to help the kids and get back the money they might need for expenses in retirement. The loans also can be used to transfer large sums to heirs without exceeding annual gift limits imposed by the Internal Revenue Service.

Digging Deeper

While a lot of lending between family members is undocumented, these formal loans appear to be on the rise. Circle Lending, a Waltham, Mass., administrator of private loans between family members and friends, has seen loan volume rise 25% per quarter for the last two years, said Jim Smith, vice-president of marketing and sales. The company has processed $150 million in loans since its inception five years ago.

For financial advisors, recommending such loans requires familiarity with the tax and estate-planning implications and an ability to deal with potentially stormy family dynamics. As such, they cut to the heart of the changing role of the Wall Street broker. No longer just selling stocks and bonds for commissions, today's financial advisors are digging deep into clients' finances and lives, and earning fees based on total assets under management.

The loans can be a useful tool for building an advisory practice. As they're often extended by parents to their children, the loans allow advisors to build ties with the next generation of clients' families, said Thomas Dedrick, a Merrill Lynch & Co. (MER) advisor in Tuscaloosa, Ala.

"We want to ensure that we have future Merrill clients out there," said Dedrick, a 48-year-old whose client base averages 60. "If we're addressing the needs of these children now who are not clients, as they mature financially hopefully they'll remember that."

Tax Implications

For clients, the loans have several advantages. They keep money within the family, so today's loan can ultimately become tomorrow's inheritance. They can be reported to credit bureaus to help a child build a good credit history. While most people are unlikely to legally pursue a family member who runs into trouble repaying, formal documentation of an intra-family loan does give the lender recourse to collect.

"The parents are as protected as the bank would be," said David Jacobs, a fee-only advisor in Kailua, Hawaii.  One risk of these loans is that they can draw scrutiny from the IRS, which can impose gift taxes and other levies if the loans aren't properly structured and managed.

"You want to make sure someone who is competent in taxes has looked at it," said Steve Morris, an accountant and certified financial planner in Norcross, Ga.  One way to keep the loan in Uncle Sam's good graces is to be sure it carries an interest rate at least equal to the applicable federal rate, or AFR, which the IRS adjusts monthly.

This rate is good for the borrower. These days a fixed-rate, 30-year mortgage averages 5.90%, while the comparable AFR is just 4.64%. It's less favorable for the lender, who could get a slightly better return by investing in Treasury notes and avoid taxable interest income by picking up municipal bonds.

While the loans offer the chance to provide a client service, they can nick an advisor's revenue if making the loan means liquidating assets the advisor manages.

"We always try and find alternate methods of helping the child before reaching in and taking assets out. As you know, the name of the game is assets under management," Dedrick said. One technique he uses is to arrange a credit line for clients against a portion of their investments housed at Merrill Lynch, which they can use to make loans to family members without touching the underlying portfolio.

Advisors can add value to these transactions in other ways. For instance, they can objectively assess the creditworthiness of the borrower, and advise the client whether it's wise to make the loan. By setting up repayments into a client's brokerage account, advisors can monitor the loan to make sure it isn't falling into arrears. If payments are late, some advisors are willing to discuss the matter with the borrower.

Advisors say open communication at the beginning is the key to a successful intra-family loan. They discuss with clients the implications of a loan default and sticky matters like how siblings might react to a loan to one child.

"In a lot of family situations," said A. Raymond Benton, a certified financial planner in Denver, "the kids are keeping a very close mental accounting."

(Scott Stearns writes about the transformation of the brokerage business from a transaction-oriented model to fee-based financial advising.)

By Scott Stearns, Dow Jones Newswires; 201-938-5293;

scott.stearns@dowjones.com