With mortgage interest rates hovering around 8%, coupled with high home prices, the cost of purchasing a home has become unaffordable for many people. Meanwhile, the 5% yield currently being offered by Treasury bonds is the highest it’s been in a long time, prompting some investors to consider buying Treasury bonds and locking in a 5% return on their money. What if you were able to make a loan to your son or daughter to help them buy a house and received a similar rate of return as a Treasury bond? The good news is that for many, this is a real possibility with an intra-family loan.
Using an Intra-Family Loan as a Mortgage
When you make a loan to your child, you must charge a minimum rate of interest. This rate is set each month by the IRS. For November 2023, the rate for loans longer than 9 years is 4.83%. While loans can be made to your child for any purpose, to qualify for the mortgage interest tax deduction, the loan must be secured by the home. There are three requirements to secure an intra-family loan for a house:
- The home must be security for payment on the debt
- In the event of default, the home can be foreclosed on to satisfy the debt
- The loan is properly recorded under state law
Any loan not meeting those three requirements can still be a valid loan, but interest payments would not be an allowable mortgage interest tax deduction. If your child (the borrower) would not benefit from the mortgage interest deduction, then it may not be necessary to go through the steps to record the loan as a mortgage.
Regardless of whether the loan qualifies as a mortgage loan, the lender still must report the interest he or she receives as income. This is no different than the interest you receive from a bond.
The Benefits of an Intra-Family Loan
So why is this a win-win? The child gets a mortgage loan from their parent at about 60% of the rate being offered by a bank and the parent gets an “investment” offering close to a 5% return. On top of that, all the money stays within the family.
But buyer beware: an intra-family loan is a debt instrument. The parent is the lender and the child is the borrower. This doesn’t always bode well for family dynamics. Ask yourself what would happen, or how you’d feel, if you couldn’t make a payment or didn’t receive a payment? Could this ruin an otherwise healthy relationship?
As with lots of wealth planning decisions, there are both financial considerations and personal considerations. A trusted wealth advisor can act as a sounding board to help you come to a decision if an intra-family loan is the right decision for you.