Help a Family Member Buy a House with a Family Home Loan

Do you have a family member looking to buy a home, but is in need of your financial assistance? Here is a great way to provide them with a personal home loan, while both you and them benefit from a tax-smart loan structure.

More Attractive Interest Rates

The prevailing mortgage rate right now is well over 6%, with no signs of coming down any time soon. A family loan can offer a more attractive solution compared to a mortgage loan. The Applicable Federal Rate (AFR) can be applied as interest, which will give the borrower a better deal and prevent you from having to deal with any tax headaches as the lender.

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

• Short-Term (less than 3 years): 4.30%
• Mid-Term (3-9 years): 3.57%
• Long-Term (over 9 years): 3.72%

As you can see, these interest rates are much more appealing than the current mortgage rates. For you, charging at least the AFR for a term loan to a family member will allow you to avoid federal income tax on the repayments. You can also avoid federal gift tax complications.

Understanding the Tax Issues

If you decide to charge less than the AFR, there may be some additional tax complications to navigate. This may be a consideration if you don’t want to charge your family member too much in interest. Some tax issues can be mitigated with the $10,000 and $100,000 loopholes, but may not be suitable for all home loans.

You must document the loan with a written promissory note. It should also be secured with the borrower’s home in order for them to claim deductions for qualified residence interest expenses. The borrower needs to sign the note, which should also include critical details like the interest rate, interest/principal payment schedule, and any security or collateral for the loan.

Conclusion

Family loans using the AFR as a basis for interest can provide home buyers with better interest rates than a commercial lender can offer with a traditional mortgage loan. Loan terms and tax consequences should be considered when structuring the loan. It helps to work with a trusted financial advisor who understands tax laws and family-related financial issues.

To learn more about family loans and how to use the AFR to your tax benefit, please contact the team at Illumination Wealth today.