The bank for moms and dads: intra-family loans

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She did all the right things: she worked hard in school, got a graduate degree, and laid the groundwork for finding a job in a well-paying career. As impressive as the successes of this young graduate are, banks are not in the habit of giving mortgage loans to the unemployed.

So why not take the bank out of the equation?

A popular workaround when someone without enough cash on hand is looking to make a large purchase is an intra-family loan, where a parent or other family member lends money as part of a formal agreement. structure. These types of loans do not present the hurdles of those offered by a bank, and there may also be other tangible benefits, including lower interest rates, flexible payment options, and estate planning opportunities. the way the loan is structured.

Along with these advantages come the common drawbacks inherent in lending money – no matter how closely related the parties are, there is always an element of risk – but a full understanding of intra-family lending can potentially offer a significant benefit to families. two parts. And often, intra-family loans can make sense even when the recipient has a well-paying job or other source of income.

Just help

The types of loans implemented in intra-family loans do not necessarily have to be family. In fact, nobody can lend to nobody, any amount, for any number of reasons, from an aunt helping a niece buy a new vehicle, to a friend helping another with capital to help start a business, to a grandparent establishing a trust to support a grandchild while moving assets out of their taxable domain.

Small loans don’t have to be structured the same way as a regular bank loan. If the amount is small enough – say, $ 10,000 from a parent to help pay for a child’s vehicle – the lender can simply transfer the funds and allow them to be considered a gift. Since the amount is below the gift tax exclusion threshold of $ 15,000 for individuals ($ 30,000 for married couples), no associated gift tax would be due, assuming the total donations for the year do not exceed the annual exclusion.

Carry the whole load

A common, and more complicated, form of intra-family loan is a mortgage. Let’s say our overperforming but cash-strapped graduate wants to buy a $ 300,000 home. Unless she’s already landed a good job and racked up enough savings for the down payment, the bank is unlikely to be interested in lending her. But if the parents can afford it, they can lend the child part of the mortgage, or the entire mortgage amount. With the guidance of their financial advisor and a lawyer, parents can build a home loan on terms that are good for their family – a loan with no money, no pre-approval, no credit check, and no background check. The child has just obtained a loan from the “Mommy and Daddy’s Bank”.

Perhaps the best part about this arrangement is that the interest payments stay with the family and will likely come back to the borrower one day as part of their inheritance. But in the short term, the interest rate they pay will not only be lower than commercial bank mortgages – it will be the lowest rate allowed by the IRS. As of July 2019, the annual compound applicable federal rate (AFR) is 2.13% for a short-term period (three years or less), 2.08% for medium-term loans (more than three years up to nine years) or 2.50% for a longer period (more than nine years).

Craft loans

When setting up a loan with your lawyer, there are several key considerations and procedural steps to take. If the loan is a mortgage, the lender must create a promissory note and deposit the mortgage in their county to make it official. In this, intra-family mortgages are different from other types of loans.

Two of the most important factors when designing the loan are to make sure that it remains distinct from a gift. Lenders can do this by setting it with an interest rate based on the current AFR and setting up an appropriate payment structure. Failure to do so may result in scrutiny from the IRS, resulting in the imposition of a potential penalty or donation tax. And, to be clear, the gift tax would be payable by the person who made the gift, not by the person who received it.

Tips for structuring the loan: I generally recommend that my clients make their mortgages interest only, with a lump sum payment scheduled for the end of the loan term. If at the end of the loan the lender wishes to refinance, he of course has the option of doing so. Likewise, if the beneficiary is unable to meet the payment schedule, the lender may decide to waive the interest at the end of each year. Again, the lender could use their annual gift tax exclusion to reverse the required payment without an exchange of money and the IRS would treat the payment as “made.”

It should be noted that in order for a loan recipient to repay the principal, they are actually just handing money over to the lender’s estate, and they probably don’t need the money if it comes from. lend the child hundreds of thousands of dollars. Another way to look at it is that the loan recipient will likely inherit part of the lender’s estate as well. So, they might wonder who will benefit most from the extra money they would apply to the principal, the younger version of themselves when they are just starting out, or the future version, which is more established in their career and is a beneficiary. money from the domain lender?

Intra-family loans can offer families a simplified way to make complex purchases, with more flexibility and on favorable terms than what they would get from a traditional bank. The key to making such a solution work is to align the loan structure with the financial means and goals of both parties, and to manage the note and all related payments and documents in accordance with regulatory requirements.

Managing Director – Wealth Planning, Waldron Private Wealth

Casey Robinson is the Managing Director of Wealth Planning at Waldron private heritage, a boutique wealth management company located just outside of Pittsburgh. It focuses on simplifying the complexities of wealth for a select group of individuals, families and family offices. Robinson has extensive experience assisting multigenerational families with estate planning, trust integration, tax planning and risk management strategies.

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