Loaning the Down Payment for Your Child’s First Home

As a parent, you want your child to build a solid financial foundation, especially as they grow their family and career. One way to help is by offering a loan for the down payment needed or entire purchase price of their first home.

In today’s blog, we’ll look at the pros and cons of loaning money to your child to help them acquire a home. From a financial planning perspective, there are several considerations to think about as you look to assist your child.

Loaning the Down Payment or Entire Purchase Amount Needed

There are various reasons to consider loaning your child money for their home, whether for the down payment or the entire purchase amount, rather than gifting the money outright. 

Some parents prefer to be repaid to protect their own financial security and retirement plans, while others see repayment as a way to teach financial discipline and accountability. Ensuring fairness among your heirs is yet another important reason to utilize a loan and formalize repayment terms. 

In some cases, parents may loan the money now and forgive the debt gradually, using a more advanced wealth management strategy that takes advantage of the annual gift exclusion amount when forgiving the debt to avoid tapping into the lifetime exemption.

Whatever the reason might be, loaning money for a child’s down payment or for the entire purchase of a property can:

• Help the child lower the mortgage payments on a conventional mortgage needed to purchase the property by acquiring better mortgage terms with the traditional lender
• Assist them in building long-term financial stability through the ownership of real estate
• Result in a faster path to building equity in an asset than they would have been able to accomplish on their own.

Tax Implications Associated with Giving Your Child a Loan

Whatever the purpose of loaning money to assist with purchasing a home, the IRS will play a role in these types of intrafamilial transactions. Suppose the loan isn’t adequately documented and a minimum interest rate isn’t charged. If this is the case, the IRS may deem the loan a gift, and the use of a parent’s annual exclusion or lifetime exemption amount might be unintentionally utilized.

The Applicable Federal Rate (AFR) is the minimum interest rate the IRS allows for private loans. It’s published monthly under Section 1274 of the tax code, determined by various economic factors, and varies based on the term and compounding period. The short-term rate is based on a loan of three years or less, the mid-term rate applies to loans from three to nine years, and a long-term loan is considered any loan with a maturity date of more than nine years from origination.

These rates are generally much lower than market mortgage rates, making intrafamilial loans attractive while satisfying IRS requirements.

For example, as of June 2025, the AFR for an annually compounding long-term loan between a parent and child is 4.77%. An annually compounding mid-term loan is 4.07%, and a short-term loan is 4%. In contrast, according to Bankrate, the average interest rates on a 30-year and 15-year fixed mortgage at the end of May 2025 were 7.02% and 6.19%, respectively.

Even with these attractive AFRs, you might not be interested in charging your child any interest. However, if less interest is charged, the IRS may impute interest, treating the difference as a taxable gift from parent to child. It could do so retroactively and apply penalties and interest. You can always charge more than the AFR, but to legitimize the transaction, you must apply an interest rate at least as high as the AFR.

Interest received is taxable and must be reported as income on your tax return on Schedule B of Form 1040. That amount is treated as a gift if interest is waived or forgiven. 

Suppose you wish to forgive a loan payment or even several payments. Each payment forgiven is considered a gift. If the total amount forgiven exceeds the annual exclusion amount available in any given year, it is reportable on a gift tax return, and the lifetime exemption amount is utilized to cover this gifted amount. As long as there is available exemption, no gift tax would be due. This can be part of an effective wealth planning strategy and is often used by high-net-worth individuals to maximize the yearly annual exclusion to preserve their lifetime exemption amount.

A promissory note should be created to bind the parties to their obligations formally. Interest paid to you may be deductible as mortgage interest by your child on Form 1099-INT if the loan is secured by the property with a recorded lien, and the home is a qualified residence. If not secured, the interest generally will not be deductible. 

A security interest in the property gives you, the lien holder, certain rights, including the right to foreclose. There is a legal process to both record a lien and to satisfy and release the lien when the note is paid in full. Accurate records of all interest payments and principal repayments should be kept.

If a conventional mortgage is involved, and you’re only lending the child the down payment necessary to purchase the property, several details must be considered:   

• Mortgage lenders will scrutinize family assistance. If funds are loaned instead of gifted, the mortgage lender will want the debt to be formally documented and included in their underwriting calculations, which could affect approval.
• A mortgage lender may also require a subordination agreement to ensure that their mortgage has a first lien holder position when assessing all liens secured against the subject property. The lender will demand this for protection purposes. 
• In the event of non-payment of either note, the lender in the primary lien position has the first claim to the home’s collateral value through a foreclosure process governed by state law.
• A subordinated loan is only paid off after all loans with a higher priority are paid in full. If there is not enough equity to satisfy all loans, subordinated liens may receive less than the full amount due after the sale of the property. So there is some risk in accepting a junior lien position, but you may have little choice.  

Why Partner with Peak Asset Management?

Partnering with Peak Asset Management can give you the support and clarity you need to help fund your child’s first home purchase. Our experienced team of Boulder CFPs ®  understands how to align this generous act with all your financial goals, ensuring your retirement plan stays on track. 

As fiduciary fee-only financial advisors, we bring practical strategies that balance family support with your long-term stability. We also recommend discussing the approach and plan with a tax professional or advisor, as lending money can be a much more complex proposition than gifting. 

When you work with Peak, you’re setting the stage for the creation of generational wealth based on prudent decisions that can benefit you and your whole family.

Connect with us to learn more about our holistic wealth management planning services. 

Jason Foster, Director of Wealth Strategies and Legacy Planning