Intrafamily loans, done right, benefit both lenders and borrowers
Intrafamily lending is gaining in popularity as credit remains tight and interest rates are at historic lows. When parents lend money to their children for a mortgage, it can create a win-win situation. Children can get their mortgage, auto or college loan at a better rate and parents can get a better return than most traditional investments.
Why intrafamily lending can be a good option
Intrafamily loans can be a good investment option for parents who have enough money to feel comfortable about making the loan, according to financial planners. Intrafamily loans can be a safe investment and earn a much higher return than certificates of deposit, treasurys or corporate bonds. But parents should only make intrafamily loans if their children are able to be approved by a commercial lender. Intrafamily loans can bring higher returns than double-A corporate bonds at 4 percent. A triple-A bond brings about 3 percent. The national average for CD’s is 0.61 percent.
What can go wrong with intrafamily loans
Lending to family members or friends is generally regarded as a bad idea. Financial planners also warn that intrafamily loans can ruin relationships, disrupt financial stability and bring down the wrath of the IRS. Children who borrow money from their parents can feel as if they have lost control over their lives that they gained by leaving home. Parents lending money to children can be burned by missed payments or default. The best thing to do is write a contract. Templates for promissory notes and other legal documents are available from numerous sources online.
Tax implications for intrafamily lending
It’s important to know that intrafamily loans come with certain tax obligations. Even if an intrafamily loan is interest-free, the IRS requires the lender to pay tax on a certain amount of interest. To keep the IRS at bay, parents need to charge interest rates the IRS sets monthly for short term loans. If the intrafamily loan is for a mortgage, hiring an attorney to register the contract with the government allows the borrower a legal tax deduction on annual interest payments.