What are the options for parents lending money to kids?

How can you safely lend money to your kids and not run afoul of the law?

Q: I read with interest one of your older articles online about the Dodd Frank Act and whether personal loans are subject to it. I want to lend money to my kids subject to a mortgage but wondered if I would be subject to governmental registration requirements under the Dodd Frank legislation.

Do parents who lend money to kids have to follow the Dodd Frank Act?

A: Thanks for your question. Back when we wrote that article it was unclear to many of us who write about real estate whether some of the requirements of the Dodd Frank legislation regulating mortgages would apply to everyone.

Many parents lend money to kids 

Frequently, parents want to loan money to their kids to help them buy a first home. Or, siblings are willing to help out with a loan. The usual scenario is that the person buying the home doesn’t have the credit necessary to get a loan from a conventional lender. In some cases, the home buyer may have gone through a divorce, loss of a job, medical issues or has other issues that could have adversely affected their credit score.

In these situations, the parent or family member is willing to lend money but will want to secure the loan with a mortgage on the property.

Dodd Frank regulates mortgage lenders, not family loans

The Dodd Frank legislation regulated mortgage lenders and mortgage lending after the Great Recession. The intent of the legislation was to set some parameters and codify regulations on how mortgage lenders work with buyers.

Over the years, it’s become pretty clear that the law did not impact the sort of family loan you want to provide.

Lending money to your kids? Have an attorney draft up the documents

Let’s say you want to help your son purchase his first home and he doesn’t have the credit to qualify for a loan. You can lend him the money and take a mortgage or trust deed back as security for the loan. We suggest that you hire an attorney to make sure you draft the documents correctly, and get the loan filed or recorded property.

Set interest rates on family loans according to IRS requirements

If you’re setting the interest rate on the loan to match other mortgage loan rates out there, that’s okay. But, if you have decided to make the loan an interest free or provide a very low interest rate loan, you might want to look at some of the Internal Revenue Service regulations regarding this issue. When you have an interest rate that is way below market, the IRS might consider that a gift – rather than a loan – from the lender to the borrower.

In your case, when you charge no interest, the IRS might decide that the interest that your kid should have paid you on the loan was a gift from you to your son. We mention this so that you keep it in the back of your mind. The IRS publishes “Applicable Federal Rates” that you can use to determine the minimum rate you can charge your son and still fall within the IRS guidelines with the interest rate not deemed a gift from you to your son.

As we wrote this column, the AFR for a monthly paid, long-term loan is around 3.3 percent, which is significantly below current market rates. If you were to charge your son something higher than that amount, you’d be fine, but if you were to charge him less, the difference might be considered a gift.

Should you give kids a gift or loan them money?

This is certainly something you should keep in mind, but there are other ways to help. You and your spouse can also give your son and his spouse an annual gift of up to $16,000 each ($64,000 per year) without triggering any gift tax issues or IRS tax filings.

On the other hand, if you make it a business to lend money to people, you might be subject to the laws and regulations that apply generally to mortgage lenders. But if you’re helping out family members, you shouldn’t have to worry about repercussions from Dodd Frank.

And as we often advise, you’d be wise to consult with an experienced, local real estate attorney about what you plan to do, to get in front of any other issues that may pop up.

Read more about family loans and mortgages:

Leaving real estate to children

Putting your child’s name on a property

4 Tips for Loaning Money to Family Members

What’s the Best Way to Help a Family Member with a Private Mortgage?