Wealth Planning Insights
Wealth Planning Insights | Intrafamily loans: Revisited
Jeff Speight, CFP®, January 2025
Intrafamily loans are a useful financial tool for helping adult children purchase real estate, invest in a business, or pay off high-interest debt. When interest rates were at historic lows, these loans made a lot of sense. With mortgage rates still double 2021 levels, it’s worth revisiting whether intrafamily loans are still practical. Before deciding to lend money to a child, parents should weigh both the financial and relational implications.
Financial Implications: The Numbers Still Work. Financially, the case for intrafamily loans remains compelling. This week, a 30-year mortgage is 7% for those with 740-760 FICO scores. In contrast, the IRS allows family members to loan money at the Applicable Federal Rate (AFR) without triggering tax penalties. The January 2025 AFR for long-term loans is 4.44%. This is a competitive bond like yield for the lender while a terrific yield advantage for the child.
Relational Considerations: Proceed with Care While the numbers may make sense, lending money within a family can be emotionally complex. To minimize potential misunderstandings, these are some basic considerations:
Put Everything in Writing: Be clear in the loan agreement. Specify the repayment schedule (include an amortization), due dates, late payment penalties, and consequences for non-payment.
Consider Relationship Dynamics: Reflect on whether you are prepared to enforce the loan terms in the event of non-payment.
Should you secure your loan? While filing a lien on the property for which the loan is made may offer some additional "protection", it also may interfere with traditional mortgage underwriting.
Other considerations It is important that you evaluate the following:
Evaluate Long-Term Impact: Think about how lending money might affect your own financial goals and retirement plans. Do not compromise your own financial security.
Understand IRS Implications: Family loans are subject to additional IRS scrutiny. If your child cannot make payments, you may be required to: a) pay income tax on unpaid interest; and/or b) treat the unpaid portion of the loan as a taxable gift.
Consult Advisors: Work with financial and tax professionals to structure the loan properly and ensure compliance with IRS regulations.
As housing affordability declines, intrafamily loans remain a practical financial tool. However, careful planning, clear communication, and professional guidance are essential. If you are considering an intrafamily loan, discuss your options with your Tanglewood advisor to help determine whether it is the right choice for your situation.