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So how does one go about properly structuring and documenting a family loan? A family loan for a mortgage done right should include:
A promissory or mortgage note that bears a minimum interest rate equal or greater than AFR (the long-term rate is now 2.67%) and spells out its term and payment dates, meaning it must be decided whether payments are to be monthly, quarterly or annually.
A mortgage or deed of trust properly recorded with correct governmental authority, which makes the mortgage secured and gives the lender the legal right to foreclose.
The income tax implications for a properly documented and recorded mortgage:
The lender records mortgage interest as income on Schedule B of their return.
The borrower can deduct mortgage interest expense as an itemized deduction.
Before making a family loan, several other issues must be considered, including whether the borrower is a spendthrift unlikely to pay you back. What is the overall family dynamic? Will you help out other family members in a similar fashion, and if you do not will that create bad blood? You need to tread carefully and consider all of these things before actually making a family loan.
People interested in making a family loan should engage financial and tax professionals to help on the front end. This is not an area to dabble in with forms from the Internet.
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