Borrowing From the Family Bank
Rachel Koning Beals
Intra-family loans offer attractive interest rates and tax advantages
The best loans may be signed across the kitchen table, not a banker's desk.
Tapping Mom and Dad for the funds to finance a home, start a business, or build a nest egg lowers the borrower's rates and allows the senior generation to still collect modest interest payments. Both generations can benefit because the loan legally reduces a future estate-tax bill. That makes intra-family loans an attractive alternative to traditional loans for adult children and the sometimes-complicated tax shelters sought by their higher-net-worth parents.
"Instead of a son or daughter borrowing money from a bank at a high rate while the parents earn very little, this cuts out the middleman, and the bank's profit instead stays in the family," says
With money market funds, government debt, and other short-term, fixed-income investing alternatives offering historically slim rates, "it's the perfect time to consider an intra-family loan," he says. Families might even consider refinancing existing family loans or third-party debt this way, given the current interest-rate climate.
Parents must ask themselves whether their own bank accounts can stand this cash depletion for a potentially long stretch of time. That means considering potential future healthcare or assisted-living expenses.
And, of course, there is potential risk to family relationships should one party not hold up their end of the deal. Emotional risk can be limited by ensuring that the transaction is formalized and involves a financial planner and an attorney. Families should have their counsel draw up a mortgage and promissory note. For a home loan, the child should obtain adequate homeowner's insurance, just as a bank would require. An intra-family home loan also has the advantage of collateral -- the property itself -- which can help soothe parents' anxiety.
A home purchase is only one reason for a family loan. Leveraging a future inheritance into a higher-performing portfolio right now is a creative investment alternative, as long as
Parents can't loan at too low a rate or the
Still, for borrowers, families are presumably lending at rates below or at the low end of what might be found in the marketplace. As of early November, the Applicable Federal Rate, the minimum
Palisades' Bergman offered this example:
Mr. and Mrs. Welloff, who are in their early 60s, lend their daughter, Jane, age 25,
Family loans can reduce federal and state estate taxes.
Currently, estates valued at more than
With a loan, children tap into their parents' estate while their parents are living. If the parents don't need the money back, the agreement can be renewed several times.
With well-constructed intra-family loans, Dedon says, "not only are you able to take advantage of a perfect storm of market factors, but done in a way that is relatively simple and tax-risk free."
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Personal Finance - Borrowing From the Family Bank
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