Are you son getting married and ask you for a loan? probably this is not your situation but could be a friend who require extra money for do it his job or to buy a house.
According to data from the Federal Reserve Board Survey of Consumer Finances, personal loans given by a consumer’s family members or friends amounts to a staggering $89 billion each year.
The interest rate issue
The Applicable Federal Rates (AFRs) are the minimum interest rates you can charge without creating any weird and unwanted tax side effects for yourself. AFRs are set by the IRS, and they can potentially change every month.
Making a loan that charges the current ultra-low AFR, instead of 0%, makes amazingly good sense — if you want to give your well-loved relative an ultra-low interest rate without causing any tax weirdness for yourself.
Current AFRs for term loans
For a term loan (meaning one with specified final repayment date), the relevant AFR is the rate in effect for loans of that duration for the month you make the loan. Here are the AFRs for term loans made in July of 2020:
- Short-term loan (one with a term of 3 years or less), the AFR is 0.14%, assuming annual compounding of interest.
- Mid-term loan (one with a term of more than 3 years but not more than 9 years), the AFR is 0.45%.
- Long-term loan (one with a term of more than 9 years), the AFR is 1.17%.
The same AFR continues to apply over the life of the loan, regardless of how interest rates may fluctuate.
As you can see, these AFRs are just a wee bit lower than rates charged by commercial lenders. As long as you charge at least the AFR on a loan to a family member, you don’t have to worry about any weird federal tax complications.
Put it in writing
Just as you would with a bank or other lender, memorialize your agreement in writing. At an absolute minimum, include the amount to be borrowed, the interest rate, the repayment timeline and terms, and the lender’s recourse if you default (for instance, will you offer any collateral to secure the loan? What penalties, if any, will you face for nonpayment?). Spelling this out in writing can substantially minimize conflicts down the road.