Should you lend your kids money to buy a home?

Couple outside a house with a real estate agent

Your baby is all grown up and ready to buy a home.

Sally (or John) could go to a traditional lender to get a mortgage. Or she (or he) could turn to the Bank of Mom and Dad.

Should you lend your child money to buy a home?

Becoming your child's lender can be financially beneficial, but it's also fraught with risk — perhaps more so than the typical investment because a family relationship is involved.

If Sally or John defaults, you have to foreclose on your own child.

Can you handle that?

On the other hand, you can earn close to 3% on a long-term loan, which is considerably more than what a savings account or certificate of deposit pays.

Your child will save on closing costs, private mortgage insurance and interest because the cheapest traditional 30-year loans charge well more than the rate you could offer.

Most parents don't lend their children money to buy a home, but it's not unheard of.

Somewhere around 6% of first-time home buyers receive a loan from a friend or relative.

If you're considering lending your child money, here are 5 facts you need to know.

Fact 1. Lending money can cause conflict.

The single most important consideration is whether you can afford to have your money tied up in a loan for an extended period.

"Generally, families that are able to provide mortgages for their children have greater wealth," says Jeff Nauta, a certified financial planner and principal at Henrickson Nauta Wealth Advisors in Belmont, Michigan.


If you think you'll rely on the mortgage payments to finance your own retirement, then late or missed payments can put you in a tough situation.

You know your child. Make sure she or he is already financially independent before considering a loan. You should not be the bank of last resort.

You need to evaluate the loan much like a bank would, which means knowing your child's credit and job history.

Often, the potential for tension outweighs the financial considerations.

"The parent-child relationship may become strained when you loan the money and are not repaid correctly or the child is constantly paying late or buying things that the parent feels are improper or causing late payments," says Tim Gagnon, assistant academic specialist of accounting at Northeastern University's D'Amore-McKim School of Business in Boston.

"Can you foreclose on your child, can you evict your child and will they see you as the first payment they should make each month?" Gagnon asks. "Can you create a business relationship, without emotions, with your child?"

Fact 2. You must follow the government's rules to avoid the gift tax.

If you want to lend your child a large sum, you have to do it right to avoid incurring gift-tax liability.

First, you must properly document the loan.

"The parents are going to have to work with a title company to create the required deed of trust documents and record these with the county in which the residence is located," says Kevin Gahagan, a certified financial planner and principal of Mosaic Financial Partners in San Francisco. "This will secure their interest in the property."

"A promissory note and mortgage should be executed between the parents and child," he says. "Without this, the parents' financial interest in the property could be jeopardized were the child to lose the house to creditors. It also provides evidence that the funds provided are a loan and not a gift."

This formal loan document should state the loan's interest rate, term and transferability, Gahagan says. It should also include an amortization table showing the balance remaining and equity accrued at any point in the loan's lifespan.

Applicable Federal Rate

Month Rate
November 2015 2.54%
December 2015 2.58%
January 2016 2.62%
February 2016 2.59%
March 2016 2.31%
April 2016 2.23%
May 2016 2.22%
June 2016 2.22%
July 2016 2.16%
August 2016 1.88%
September 2016 1.88%
October 2016 1.95%
November 2016 2.05%
December 2016 2.24%
January 2017 2.72%
February 2017 2.78%
March 2017 2.75%
April 2017 2.79%
May 2017 2.72%
June 2017 2.65%
July 2017 2.57%
August 2017 2.55%
September 2017 2.57%
October 2017 2.47%

To determine what interest rate to charge, you'll need to go to and look up the "applicable federal rate" for the month and year in which you finalize the loan.

During October 2017, for example, the applicable federal rate for long-term loans was 2.47% if the interest is compounded monthly. That's 1.57% percentage points less than the average 30-year mortgage interest rate.

There are significant (and complicated) tax consequences if you don't charge at least this amount. Failure to do so could create a gift, or the IRS could deem the uncharged interest to be income and tax it.

Also, if parents forgive the loan or don't pursue collection actions, the IRS may consider it a gift, Gagnon says, and if the loan is forgiven, the child may have to report it as income and pay tax on it.

Gift tax issues are complicated — yet another reason why you should engage competent professionals to help you structure the loan and understand all of the details.

For 2016 and 2017, the annual gift tax exclusion is $14,000. This amount applies to each recipient, and each spouse can give this amount tax-free.

The maximum amount parents could give a child without incurring gift-tax liability would be $56,000 if each parent gave $14,000 to both their child and the child's spouse.

Even the maximum amount is far less than most mortgages.

Fact 3. You also must follow rules to deduct mortgage interest.

Following the steps to avoid the gift tax will get you most of the way toward making sure your child can deduct mortgage interest payments.

Here are the additional steps:


Fact 4. There are companies that can help you formalize your loan agreement.

A third-party financial institution can simplify the loan process and increase the likelihood your child will pay you back.

One such intermediary is Boston-based National Family Mortgage, which has handled more than $400 million in loans while keeping more than $180 million of interest within families.


More than 4 of every 5 of National Family Mortgage's loans are between parents and their adult children.

Fees for this service run from $725 for loans of $100,000 or less to $2,100 for loans of $1 million or more.

For an additional $15 a month, National Family will "service" the loan by sending monthly statements, collecting payments and providing year-end tax forms.

The company says the default rate is less than 1% on the loans it manages.

Fact 5. This type of loan won't show up on credit reports.

A loan between family members cannot build or damage the borrower's credit because it is not reported to credit agencies.

Parents can't report the loan to the credit bureaus even if they want to because TransUnion, Experian and Equifax have rigid, cumbersome and expensive reporting requirements that few family lenders can meet, according to Tim Burke, the CEO of National Family Mortgage.

The agencies also have legitimate concerns that intrafamilial loans have an inherently biased creditor relationship and could be abused to help a borrower build credit.

If a child missed a mortgage payment, the parent might be tempted to grant amnesty by informing the credit agencies that no payment was due.

  • Duncan

    If I sell a rental house I own to my son how are my capital gains taxes on the house calculated? (I think just the principal paid each year is somehow taxed as cap gains-so this would postpone cap gains on the house?). Also when I die if there is still a bunch of principal left on the loan, is the loan valued at time of death in the estate and no further capital gains taxes are assessed? If so what would my son's tax basis be on the house? Sorry if this doesn't make sense.

  • Jon Loether

    Can a note be setup with a deferred first payment (12-24 months past closing) contingent on the sale of another house similar to how credit card companies allow you to have Xmonths of no payments or 0% interest and avoid issues with the gift tax?

    • Matthew

      I don't think so on the 0% interest idea; you'd be below the IRS imputed rate for those first months so the interest that would have been due would be considered taxable and a gift to the buyer. You can, however, make interest only payments for the first X months (or even set the payment below the interest amount and allow the loan balance to rise for a time).

  • Matthew

    Misleading. Publication 936 clearly states the following:

    Secured Debt

    You can deduct your home mortgage interest only if your mortgage is a secured debt. A secured debt is one in which you sign
    an instrument (such as a mortgage, deed of trust, or land contract) that:
    -Makes your ownership in a qualified home security for payment of the debt,
    -Provides, in case of default, that your home could satisfy the debt, and
    -Is recorded or is otherwise perfected under any state or local law that applies.

    Recording the mortgage is an IRS requirement for deducting mortgage interest. I'm not sure how that impacts a strategy focused solely on avoiding the gift tax, but if we're talking about a mortgage anyway why wouldn't you record it in order to give your child that deduction?

  • Matthew

    My take would be that so long as the interest rate that is eventually settled upon is above the IRS imputed rate when the loan was first made and when the modification takes place you will be fine on the gift tax (I'm not sure which point in time the IRS would consider pertinent in this situation)

  • rainman

    Your article states that IRS forms 1098 and 1099, but is the required? I have read conflicting articles on this. As long as both the deducting party and the receiving party both file the same amount, and are not doing this as a business, is it necessary to file the forms?

  • Ron Bonnell

    What is unclear, you say "Failure to do so could create a gift, or the IRS could deem the uncharged interest to be income and tax it."

    So which is it? A gift, or uncharged interest to be taxed?

    Those are hugely different.

    I wouldn't care if it were a gift. It would still be under the tax threshold.

    I don't want the tax liability of the interest because I am in a high bracket and the deduction wouldn't help my son at all because he does better with the standard deduction.

    So my plan is to have the loan, and give him the interest as a gift.

  • Rich

    How come Dodd-Frank rules are not being brought up? I read a parent can not loan money to a child for a residential home that they "live" in? Can you expand on this. Any issue with giving a loan and sending the form IRS 1098 to the child each year so they can deduct the interest on their taxes. Thanks!

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  • ted wood

    I like to loan my son a large sum charging an IRS approved interest rate. Can I set it up so the interest is compounded annually with all the interest and the principle to be paid back after 10 years? This would give me a choice of forfeiting the loan and interest then, provided his marriage is stable. Would he have to deduct interest payment for tax annually or only at the end?