Can Parents Loan Money for a Down Payment?
Guiding parents through the complexities of helping with a down payment for a child's home purchase.
Providing financial assistance for a down payment helps family members achieve homeownership. This practice involves considerations for parents providing funds and the child receiving them. Understanding financial arrangements, lender requirements, and tax implications is important. Proper planning and documentation ensure the support serves its intended purpose.
Lender Requirements for Down Payment Funds
Mortgage lenders assess down payment fund sources to ensure a borrower’s ability to repay a home loan. Lenders distinguish between funds received as a “gift” or a “loan.” Gifted funds do not add to the borrower’s debt-to-income ratio, favoring mortgage approval. Loaned funds, however, create new debt, impacting eligibility.
To confirm funds are a gift with no repayment expectation, lenders require a gift letter. This document must include the donor’s name, relationship to the borrower, exact dollar amount, and transfer date. It specifies the funds’ purpose and states no repayment is expected. The letter also confirms the giver has no ownership claim to the home.
Lenders scrutinize “seasoning” of funds, meaning the time money has been in the borrower’s account. Most lenders prefer funds to be “seasoned” for at least 60 to 90 days prior to application. This verifies funds are genuinely available and not temporarily borrowed. Large, unseasoned deposits may prompt lenders to request additional documentation to trace the source.
Structuring the Parent-Child Financial Arrangement
Parents can structure down payment assistance as a gift or a loan. A gift simplifies the process with the lender, as it creates no debt for the child. However, gifts can have tax consequences for parents if they exceed certain thresholds.
Structuring assistance as a loan requires a legally sound agreement. This involves a written promissory note detailing the loan terms. The note should state the principal loan amount, interest rate, and a repayment schedule. Provisions for late payments or default can protect the lender and clarify expectations.
The interest rate for a family loan should be at or above the Applicable Federal Rate (AFR) to avoid tax complications. The IRS publishes monthly AFRs, varying by loan term. Charging below the AFR can cause the IRS to reclassify interest as a taxable gift, leading to imputed interest income for the parent. A formal loan establishes a clear financial understanding and allows parents to transfer wealth while potentially earning interest.
Tax Considerations for Parents and Child
Tax implications for down payment funds vary by gift or loan structure. For gifts, parents can use the annual gift tax exclusion, allowing up to $19,000 per recipient in 2025 without reporting. Married couples can gift up to $38,000 annually. If a gift exceeds this, the parent must file IRS Form 709.
Exceeding the annual exclusion does not automatically result in gift tax liability. The excess reduces the giver’s lifetime gift tax exemption ($13.99 million per individual for 2025; $27.98 million for married couples). Gift tax is paid by the donor, not the recipient, and most individuals will not owe actual gift tax due to this high exemption. A gift is not taxable income for the child.
For loans, the primary tax consideration is imputed interest if the rate is below the AFR. If parents charge a lower rate, the IRS may “impute” interest, treating the difference as taxable income to the lending parent. Exceptions exist for small loans; those of $10,000 or less are exempt if not used for income-producing assets. The loan principal is not taxable income for the child, and interest paid on a personal loan from a parent is not tax-deductible for the child.
Formalizing the Agreement and Required Documentation
Clear documentation is important for parental financial assistance, satisfying lenders, and adhering to tax regulations. For gifts, a gift letter is the primary document required by mortgage lenders. This letter should be signed by the donor and include their name, address, phone number, relationship to the borrower, and the exact gift amount. It must explicitly state the funds are a gift with no repayment expectation and that the donor has no interest in the property. Lenders may also require bank statements from both parties to verify the transfer and source.
When structured as a loan, a well-drafted promissory note serves as the legally binding agreement. This note should detail the loan amount, the agreed-upon interest rate (at least the Applicable Federal Rate), and the full repayment schedule. It is advisable to include provisions for late payments or default, such as acceleration clauses. Notarizing the promissory note can be beneficial, though not legally required. This documentation helps prevent misunderstandings and provides evidence if reviewed by external parties like the IRS.