The Intrafamily Loan Strategy: How to Be the Bank for Your Kids and Beat Mortgage Rates
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Result: The family unit saves nearly $700k from leaving the circle.
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The Intrafamily Loan Strategy: How to Be the Bank for Your Kids and Beat Mortgage Rates
CORE INSIGHTS
- Interest Arbitrage: The IRS sets a minimum rate (AFR) for family loans, often 2-3% lower than banks. This “spread” stays in the family.
- Wealth Circulation: Interest paid by the child becomes income for the parent. Instead of paying a bank, the family keeps the wealth.
- Flexibility: Family loans can have custom terms (e.g., interest-only) that banks won’t offer, helping children start out.
When a child needs money, many parents gift it. A smarter play is often to Lend It. By using the Applicable Federal Rate (AFR), you can provide cheap capital without triggering gift taxes.
What-If Scenario: The $500k Home Loan
| Lender | Interest Rate | Total Interest (30 Yrs) |
|---|---|---|
| Commercial Bank | 7.0% | $697,000 (Lost) |
| Family Bank (AFR) | 4.5% | $412,000 (Kept) |
Visualizing the Interest Gap
*Figure 1: Interest Cost. The Family Loan (Green) keeps wealth internal; Bank Loan (Red) leaks it out.*
Strategic Action Steps
1
Check Current AFRs
Visit the IRS website. Rates change monthly. Choose Short (0-3 yr), Mid (3-9 yr), or Long-Term (>9 yr) rates.
Visit the IRS website. Rates change monthly. Choose Short (0-3 yr), Mid (3-9 yr), or Long-Term (>9 yr) rates.
2
Draft a Promissory Note
Use a service like National Family Mortgage. It must specify rate, schedule, and collateral. Do not use a napkin.
Use a service like National Family Mortgage. It must specify rate, schedule, and collateral. Do not use a napkin.
3
Manage Payments
The child must pay. If not, the IRS may deem it a Gift. Parents must report interest income on their tax return.
The child must pay. If not, the IRS may deem it a Gift. Parents must report interest income on their tax return.
The Bottom Line: Who Should Choose What?
- Choose Family Loan: Parents with cash seeking safe returns (>4%) who want to help kids buy homes.
- Choose Gift: If the amount is small (<$100k) or you want simplicity. Use the Annual Exclusion ($19k).
Frequently Asked Questions
What is the Applicable Federal Rate (AFR)?
The minimum interest rate the IRS requires on family loans to avoid gift tax. It is typically much lower than commercial mortgage rates.
Do I have to pay taxes on the interest?
Yes. The lender (parent) must report the interest as taxable income. However, the money stays in the family circle.
Can I forgive the loan later?
Yes. You can use your Annual Gift Tax Exclusion ($19,000) to forgive interest or principal each year, converting it to a gift over time.
Disclaimer: This content is for informational purposes only. Loans must be properly documented. Consult a tax professional.