Wealth and Legacy Planning
In this day and age, when adult children or grandchildren need to borrow money—whether to buy a first home, launch a business or finish a degree—the options are often expensive. Mortgage rates hover near 6% and personal loans run into double digits.
Gifting money can be one solution, but sometimes there are constraints or limits to how much we want to give. However, parents and grandparents can lend a hand (and a sizable sum) without running afoul of annual or lifetime gift tax consequences by offering a family loan, either personally or via trust entities that may be in place. A structured lending arrangement can provide below-market financing and flexibility for the borrower and retain repayment rights for the lender. It’s a practical tool for transferring opportunity across generations.
How It Works
With the assistance of your attorney or an experienced advisor like RWA, you would create a formalized, legally binding loan agreement between family members. It allows you to provide capital to a borrower within the family at an interest rate that meets IRS requirements but remains well below commercial alternatives.
The IRS publishes applicable federal rates (AFR) monthly. These are minimum rates that must be charged to avoid the loan being treated as a gift. For January 2026, these rates are 3.63% for short-term loans (up to three years), 3.81% for mid-term (three to nine years) and 4.63% for long-term (over nine years). Rates are locked at origination, and loans can be structured as interest-only or with principal and income payments.
Rate Comparison: Family Loans vs. Commercial Alternatives
The table below illustrates the potential savings of family bank financing versus traditional options.
Rate Comparison: Family Loans Vs. Commercial Alternatives
| Loan Type | Rate | Typical Term | Common Use | Notes |
|---|---|---|---|---|
| Family Bank (Short-term AFR) | 3.63% | Up to 3 years | Bridge financing, education | Rate locked at origination |
| Family Bank (Mid-term AFR) | 3.81% | 3–9 years | Business startup, vehicle | Rate locked at origination |
| Family Bank (Long-term AFR) | 4.63% | 9+ years | Home purchase | Rate locked at origination |
| 15-Year Mortgage | 5.25% | 15 years | Home purchase | Requires qualification |
| 30-Year Mortgage | 5.87% | 30 years | Home purchase | Requires qualification |
| Home Equity Line of Credit (HELOC) | 7.44% | 10-year draw | Home improvement, consolidation | Variable rate |
| Personal Loan | 12.20% | 3–5 years | Debt consolidation, major purchase | Credit score dependent |
Sources: IRS (AFRs), Zillow (mortgage), Bankrate (personal loan and HELOC). Rates as of January 2026.
Family Bank Savings Opportunities
The rate differential is significant. A child borrowing $300,000 for a home purchase at the long-term AFR of 4.63% rather than a 15-year mortgage at 5.25% saves roughly $100 per month in interest payments—about $1,200 annually. Over the life of the loan, that’s more than $18,000 that stays within the family rather than going to a bank.
Beyond the math, a family loan can accomplish what an outright gift cannot: It creates accountability and establishes a framework for ongoing financial dialogue between generations. The regular payments become a touchpoint, a reminder of shared commitment to family values.
Logistics of a Family Loan
A family loan requires a written promissory note specifying the principal, interest rate (at or above the applicable AFR), repayment schedule and consequences of default. If the loan is secured by real estate, the mortgage or deed of trust should be recorded, especially to ensure the borrowers can claim the mortgage interest deduction up to the maximum benefit. The lender reports interest income on their tax return. Payments must actually be made—and tracked—or the IRS may recharacterize the arrangement as a gift. Advisors like RWA perform this function routinely.
Important Considerations
Family loans aren’t without risk. The most obvious: What happens when a borrower can’t—or won’t—make payments? Enforcing a promissory note against a child or grandchild creates relationship strain that no interest-rate savings can justify. Lenders should also consider whether the capital might be needed elsewhere, the tax consequences of making funds available for the loan, etc. There is real opportunity cost to contemplate. This is why many lenders will liquidate fixed-income securities within their portfolio to the extent they can, substituting the loan with its AFR for bonds in their view of asset allocation. In short, you trade some bond interest payments for loan repayments in your portfolio.
Consider these factors carefully and set expectations appropriately so that the loan does not become a source of stress and resentment. Remember, the point is to use your resources to enable your child or grandchild to embark on the life they want—a life you likely wish to be a welcome part of.
A Legacy That Connects
Done well, a family loan is more than a legal and financial arrangement—it’s an expression of confidence in the next generation’s ability to build something meaningful. It’s an opportunity to lend help when they most need it, keep wealth savings in the family, and open the door to home ownership, continuing education or the start of a new venture during your lifetime.
If you’re interested in exploring whether a family loan might work for your situation, we are here to lend our expertise.
The information set forth in this communication is presented by RWA Wealth Partners, LLC (“RWA”). The contents are for informational and educational purposes only and are not intended as investment, legal or tax advice. Please consult with your investment, legal or tax advisor concerning any specific questions you may have. Past results are not indicative of future performance. The historical return of markets generally and of individual asset classes or individual securities may not be an accurate predictor of future returns of those markets, asset classes or individual securities. RWA does not guarantee the accuracy and completeness of any sourced data in this communication.
