On June 10, the Federal Reserve announced that it is unlikely they will raise interest rates until 2022. This is good news for borrowers, as low-interest rates may spur additional spending. The other side of the coin is that for investors in the bond market or savings and money market accounts, lower rates penalize conservative investors.

Here we will discuss the benefits to low-interest rates.

As parents, we are always concerned about our grown children or grandchildren’s ability to survive a financial crisis like the one we are experiencing. The loss of a job or a reduction in pay can wreak havoc on one’s ability to pay bills. We want to help, but the offer of a gift may be met with resistance out of pride or a desire not to be a burden.

Loaning the money, rather than gifting it, may be more appealing to your child or grandchild. The current low-interest-rate environment can make it more affordable for them to repay you. While the IRS mandates that interest be charged on a loan given to a family member, the interest rate you can charge is likely lower than any rate your child can receive from a bank or other lender.

It is important to formalize any loan agreement in writing and include repayment terms, such as when payments are due (e.g., monthly or quarterly), when the loan is to be paid in full, and what interest rate is being charged.

Loaning money to your children or grandchildren can also have pitfalls, especially if they fall into further financial trouble and find they cannot repay you. If you disagree with their definition of what constitutes not being able to repay you, it could cause hard feelings.

But given the financial situation we find ourselves in and the fact that interest rates are so low, this strategy should be considered.

How Low Can You Go When Charging Interest on an Intrafamily Loan?

Assuming that your goal is not to maximize the interest income you receive on the funds you lend your child or grandchild, what is an appropriate rate of interest to charge them?

Traditional finance theory says the rate of interest that should be charged is commensurate with the risk of not being repaid relative to a risk-free rate of interest. But let’s assume you wish to charge the lowest rate possible. For that rate, you would look to the IRS.

Each month the IRS publishes rates that can be used to determine what interest rate to charge on loans to family members. These rates are referred to as the Applicable Federal Rate (AFR) and are broken out by loan maturity. Short-term rates are for loans less than three years. Mid-term rates are for loans that mature between three and ten years, and long-term rates are for maturities greater than ten years.

Currently, these rates are at historic lows. For example, the rates (annualized) for June are as follows:

  • Short-term         .18%
  • Mid-term             .43%
  • Long-term           1.01%

 A Unique Opportunity to Refinance Existing Loans

These low rates also present an opportunity to refinance existing loans and reduce borrowing costs. Rates have dropped so quickly that even loans originating in December 2019 had significantly higher interest rates. As an example, short-term rates have dropped by 90% since December 2019.

Intrafamily loans can be messy, and it is not always the right way to go for both borrowers and lenders. But given that the need for financial assistance for many is great and the current interest rate environment is low, this type of loan should be considered.

If you need help deciding if this strategy is right for your family, please call your advisor.