There may be a number of reasons to consider loaning money to a child to purchase a property, whether it is the down payment or the entire amount needed to buy the home. Some parents may want to help their child, but really do need the money returned over time because it is a critical part of their financial and retirement planning. Others do not need the money returned but might prefer the money be paid back for accountability reasons. In this approach, the parent may be proposing a loan versus a gift because there is an educational component involved in taking on debt and paying back a loan with interest, assisting the adult child with real world financial literacy.
Regardless of the reasoning for the loan, the IRS also plays a role in these types of intrafamilial transactions. In order for the loan not to be considered a reportable gift, a certain interest rate needs to be charged on the amount loaned. The minimum amount of interest that can be charged on these private loans is determined by the IRS through an interest rate index called the Applicable Federal Rates (AFRs). These interest rates are determined by a variety of economic factors, including prior 30-day average market yields of corresponding U.S. treasury obligations (T-bills). Each month the IRS publishes a new set of interest rates for short-term, mid-term and long-term loans, and the AFR rate will depend on the length of time needed to pay the obligation back and the compounding period.