Secure your family mortgage and future

I had a client call me heartbroken last month

They wanted to buy a home in 2020 for their growing family, but everyone told them not to because the market would crash. I encouraged them to buy now because the interest rate was less than 3%. While prices are higher, they have yet to reach their peaks. During Covid, there was so much displacement. People were embracing their new remote work freedom and relocating across state lines. It drove up prices, but the interest rates were so darn competitive. Long story short, I didn’t win their approval, and they opted not to buy.  

Unfortunately, they are in a rough position, as the family has grown and they need space. They are buying the same home for $200K more with a mortgage payment. That's $1,000 more than it would have been three years ago.

The IRS issues new AFRs for term loans every month:

The rates for April 2023 are as follows:

• Short-term loan (three years or less): 4.86%

• Mid-term loan (over three years but not more than nine years): 4.15%

• Long-term loan (over nine years): 4.02%

Charging at least the AFR for a term loan to a family member allows you to avoid federal income tax and federal gift tax complications. But, if you charge less than the AFR, you may need to navigate some tax complications.

Two tax-law exceptions, the $10,000 and $100,000 loopholes, can help you avoid these complications, although they may not be suitable for all home loans. It is crucial to document the loan with a written promissory note and secure it with the borrower's home for them to claim deductions for qualified residence interest expenses. Double check the borrower signs the note and the note includes details such as the interest rate, a schedule of interest and principal payments, and any security or collateral for the loan.

This is interesting

I was interested in looking more into this situation, and there’s one option that I’m encouraging them to consider: Leverage family loans to secure a better rate. Here’s some information on how you can help a family member buy a home by making a loan to them while ensuring that you and the family member benefit from a tax-smart loan structure. With the current national average interest rates for a 30-year and 15-year fixed-rate mortgages at 6.81% and 6.13%, respectively, family loans can offer a much more attractive alternative. By charging the Applicable Federal Rate (AFR) as interest, you can give the borrower a good deal without giving yourself a tax headache.

In conclusion

Family loans can provide homebuyers with better interest rates than commercial lenders offer, especially if family members charge the AFR. Over the life of a mortgage loan, this could save them north of $400,000 of interest. Not bad, right?  Remember to consider the loan terms and tax consequences when structuring the loan.

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