Using Family Loans to Secure Better Home Loan Interest Rates

Here’s some information on how you can help a family member buy a home by making a loan to them while ensuring that you and the family member benefit from a tax-smart loan structure.

With the current national average interest rates for 30-year and 15-year fixed-rate mortgages at 6.81 percent and 6.13 percent, respectively, family loans can offer a much more attractive alternative. By charging the Applicable Federal Rate (AFR) as interest, you can give the borrower a good deal without giving yourself a tax headache.

The IRS issues new AFRs for term loans every month. The rates for April 2023 are as follows:

• Short-term loan (three years or less): 4.86 percent
• Mid-term loan (over three years but not more than nine years): 4.15 percent
• Long-term loan (over nine years): 4.02 percent

Charging at least the AFR for a term loan to a family member allows you to avoid federal income tax and federal gift tax complications.

But if you charge less than the AFR, you may need to navigate some tax complications. Two tax-law exceptions, the $10,000 and $100,000 loopholes, can help you avoid these complications, although they may not be suitable for all home loans.

It is crucial to document the loan with a written promissory note and secure it with the borrower’s home for them to claim deductions for qualified residence interest expenses. Make sure the borrower signs the note and that the note includes details such as the interest rate, a schedule of interest and principal payments, and any security or collateral for the loan.

In conclusion, family loans can provide homebuyers with better interest rates than commercial lenders offer, especially if family members charge the AFR. Remember to consider the loan terms and tax consequences when structuring the loan.