Dear Dr. Don,
I have relatives who are willing to loan us $100,000 for the down payment on a home. They are not interested in charging us interest, nor are they holding us to any strict repayment timetable.

We’ve read that if they don’t charge us interest, the IRS will anyway. To that end, what interest rate “should” they be charging us to satisfy the IRS?

As borrowers, are we held by the terms of the loan? If they gift us the maximum $48,000 that they can (two of them, two of us) and the loan is for $52,000, should they simply wire transfer $100,000 while we have the loan paperwork ready for anyone who wants to see it? Or should we have them write four separate checks (for the gifts) and wire the remainder?

Paul Payment

Dear Paul,
The issues you raise here are a lot more complicated than just managing the gift tax issue on an interest-free loan. Your relatives need professional tax advice in how to structure the loan and any potential gifts of interest or principal.

One issue is your creditworthiness as borrowers. Another is the terms of the loan. A third is whether they will owe income tax on the imputed interest income. The best primer I’ve read on this topic is SmartMoney’s ”
Loans Among Family Members.” It explains all these issues in greater depth.

Bankrate also has an informative piece on the subject called ”
Tax implications of a family loan.”

That said, these articles are not substitutes for professional tax advice.

A final consideration is in how the mortgage lender will view your relatives’ loan of the down payment. Even an interest-free loan has a debt service expense surrounding the repayment of the principal balance.

If the loan of the down payment is structured as a demand loan, as suggested by the above referenced article, then the mortgage lender is going to be concerned about the possibility that the down payment loan is called.

Hiding the loan from the mortgage lender isn’t the answer. Working with the lender is the answer.

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