November 30, 2022

How To Structure A Family Loan

Most high-net-worth clients consider a successful wealth transfer to the next generation as one of their highest priorities. Balancing helping the next generation get a head start without being an enabler, or doing more harm than good, is a delicate balance that requires extreme care. With this idea in mind, many often wonder: Should I gift to my children outright while I am living? There are many positives to outright gifting: getting money out of your estate and seeing how your children actually utilize the gift being two of the most significant.

But, as the name suggests, an outright gift is irrevocable in nature. Once the money has been gifted, it is the giftee’s money to use at their discretion. So, how can a high-net-worth individual begin helping the next generation without simply handing over significant wealth?

An alternative to gifting is to structure an intra family loan, when applicable. This could be appropriate if a high-net-worth client is looking to help their child with a home purchase or a business investment, for example.

For example, let’s assume the lendee is looking to purchase a $500,000 home. In a traditional sense, he/she would look to put down 20% ($100,000) as a down payment, be subject to expected closing costs, and lock in a 30-year fixed interest rate somewhere in the neighborhood of 7% (as of writing in November 2022).

Instead, the lender and lendee could structure a family loan. In this example, the lendee would receive the $500,000 directly from the lender in the form of a loan. Family loans are structured using the applicable federal rates (AFRs), which are published by the IRS each month. The long-term AFR as of writing is 4.34%, as opposed to the 7% the lendee would receive from a bank. It’s important to note that the IRS considers annual interest as taxable income to the lender.

The lendee benefits from this– as he/she will be on a payment plan based on a signed written agreement between all parties. Additionally, the lendee could pay significantly less in interest over the life of the loan by using the lower AFR, as well as avoid putting down a down payment and traditional closing costs for the home.

The lender also sees benefits, as he/she may be able to transfer wealth to the next generation without using up any of their lifetime gift exemption, currently set at $12.06M in 2022 (this is set to drop approximately by ½ this amount in 2025). Additionally, the lender will be able to see how the lendee responds to receiving wealth, but not having the transfer be of the irrevocable variety. If structured correctly– a family loan for wealth transfer can be the best of both worlds. The lendee is able to properly get a head start without having to go through some of the headaches of traditional financing. The lender is able to help and not have it count towards any potential future estate tax. It’s important to note that if the borrower is unable to repay the loan, the IRS will consider the loan to be a gift (which could have estate and gift tax consequences).

If structured correctly, a family loan can be an efficient wealth transfer strategy. Please consult with a financial professional and / or an estate attorney to make sure that a family loan makes sense for you and your personal financial situation.


Equilibrium Wealth Advisors is a registered investment advisor. The contents of this article are for educational purposes only and do not represent investment advice.

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