1. Introduction
Quick Answer: Family loans go wrong for two reasons: nobody wrote it down, and nobody picked a rate. Both are fixable in an afternoon. DollarVisor shows the math behind every figure here, and our loans coverage compares the alternatives.
Lending inside a family looks simple. Someone needs $30,000 for a down payment, a parent has it in savings, and no bank is involved.
Then the questions start. Do we charge interest? Does the IRS care? What if she can’t pay? Is this a gift?
This page answers them in order: what the agreement must say, the federal minimum rate, your state maximum, the dollar lines that decide whether taxes apply, and what happens if the money never comes back.
First, a short walkthrough of what a written family loan agreement covers.
2. What is a family loan agreement, and when do you need one?
Quick Answer: A family loan agreement is a promissory note signed by two relatives, recording the amount, the rate, the schedule and what happens if a payment is missed. Write one any time the sum tops about $10,000, or any time you would be upset never to see it again.
The document does two jobs, and people think about only the first.
- It makes the debt collectable. A signed note with a rate and a due date is enforceable in court. A text saying “I’ll pay you back” usually is not.
- It proves the transfer was a loan, not a gift. This job matters more often. Without a note, the IRS can treat the whole amount as a gift, and you cannot claim a loss if the borrower defaults.
That second job explains the low threshold. Unlike secured and unsecured bank loans, a family loan has no institution building a paper trail. You are lender, underwriter and record keeper.
Not sure a family loan is the right call?
Credit unions often price small personal loans lower than most people expect, and nobody at Thanksgiving has to know. Compare credit union rates against banks →
3. What has to be in the agreement
Quick Answer: Eight items: names, principal, interest rate, payment amount and frequency, start and end dates, late terms, security if any, and both signatures with a date. Anything shorter reads as an intention rather than a debt.
In order:
- Full legal names and addresses. “Mom” is not a party to a contract; use the names on ID.
- The principal, in figures and words. Note the date it moves, and move it by transfer or check.
- The interest rate, stated yearly. Say whether it is simple or compounding, and how often.
- Payment amount and frequency. Monthly is easiest to track and easiest to prove.
- First payment date and maturity date. Maturity sets which federal rate applies, so pick it first.
- What happens if a payment is late. A grace period and a modest fee is enough.
- Security, if any. A car title or recorded lien turns an unsecured promise into a secured one.
- Signatures and the date. Notarization is optional in most states, costs about $15, and ends any argument.
Add what most templates leave out: an amortization schedule. A one-page table splitting each payment between principal and interest is the best evidence this was a real loan. Our guide to how loan interest is calculated shows the math.
4. The IRS floor: the minimum interest you must charge
Quick Answer: The IRS publishes an Applicable Federal Rate every month. For August 2026 it is 4.10% on loans of three years or less, 4.35% out to nine years, and 4.92% beyond, compounded annually. Charge less and the gap becomes imputed interest you report as income.
The rate locks in the month the loan is made and stays fixed for the life of a term loan. Which tier applies depends only on the maturity date.
| Loan term in the note | Annual | Semiannual | Quarterly | Monthly |
|---|---|---|---|---|
| Short-term: 3 years or less | 4.10% | 4.06% | 4.04% | 4.03% |
| Mid-term: over 3 up to 9 years | 4.35% | 4.30% | 4.28% | 4.26% |
| Long-term: over 9 years | 4.92% | 4.86% | 4.83% | 4.81% |
Source: IRS Revenue Ruling 2026-13, Table 1. Compiled by DollarVisor, August 2026.
The rate changes monthly, so check the current month’s ruling on the IRS site rather than reusing a template figure. A demand loan, with no fixed end date, cannot lock a rate at all: it floats with the short-term rate, which is reason enough to write a maturity date.
In August 2026 a ten-year family loan has to charge at least 4.92%: more than a full point above the three-year minimum.
Charging below the floor is not illegal. It makes the deal a below-market loan under Section 7872, recalculated as if you had charged the AFR and handed the interest back as a gift. Section 6 covers when that costs anyone money.
5. The state ceiling: the maximum you’re allowed to charge
Quick Answer: Banks and licensed lenders are exempt from most state usury caps. Private individuals are not. In Pennsylvania an ordinary lender is capped at 6%, in Michigan 7%, in Ohio 8% and in Illinois 9%: leaving only a few points of room above the federal floor.
This is the half nobody checks, and the half with real penalties.
| State | Ceiling on a written personal loan | Statute |
|---|---|---|
| California | 10% for personal or family use | Const. art. XV, § 1 |
| Texas | 10%, the default ceiling | Fin. Code § 302.001 |
| Florida | 18% up to $500,000 | Fla. Stat. § 687.03 |
| New York | 16% under $250,000; over 25% is criminal | Gen. Oblig. Law § 5-501 |
| Pennsylvania | 6% up to $50,000 | 41 P.S. § 201 |
| Illinois | 9% in writing | 815 ILCS 205/4 |
| Ohio | 8% up to $100,000 | R.C. § 1343.01 |
| Georgia | 16% up to $3,000; any written rate above | O.C.G.A. § 7-4-2 |
| North Carolina | 16% or T-bill+6% up to $25,000; 36% under $5,000 | G.S. § 24-1.1 |
| Michigan | 7% in writing | MCL 438.31 |
Sources, official state code and regulators: California, Texas, Florida, New York, Pennsylvania, Illinois, Ohio, Georgia, North Carolina, Michigan. Compiled by DollarVisor, August 2026.
Put the two tables side by side and the picture changes. A Pennsylvania parent making a ten-year loan must charge at least 4.92% for the IRS and no more than 6% for the state: a corridor barely a point wide. Michigan leaves two points, Illinois about four.
Getting it wrong is not a paperwork issue. Usury penalties typically strip the lender of the interest, and in New York charging above 25% is a crime. In a tight-corridor state, sit at the AFR and go no higher.
6. When the tax rules actually bite: four dollar lines
Quick Answer: Below $10,000 the below-market rules do not apply. Between $10,000 and $100,000, imputed interest is capped at the borrower’s net investment income and treated as zero if that income is $1,000 or less. Above $100,000 the full forgone interest counts.
Most family loans never trigger a tax bill. These thresholds are why, and they stack in order.
| Threshold | 2026 amount | What crossing it does |
|---|---|---|
| De minimis exception | $10,000 | Below it the rules are off, unless the money buys income-producing assets |
| Net investment income floor | $1,000 | At or under this, the borrower’s imputed interest is treated as zero |
| Gift loan cap on the income limit | $100,000 | The full forgone interest counts, not just the borrower’s investment income |
| Annual gift tax exclusion | $19,000 per recipient | Forgone interest and forgiven principal below this need no gift tax return |
| Lifetime exclusion amount | $15 million | What excess gifts are deducted from, rather than taxed on the spot |
Sources: 26 U.S. Code § 7872; IRS 2026 inflation adjustments. Compiled by DollarVisor.
A common case: a parent lends an adult child $40,000 interest-free for a car. That is over $10,000, so the rules apply. But it is under $100,000, and the child’s savings throw off maybe $300 a year: under the $1,000 floor. Imputed interest is zero and nobody reports.
Raise it to $150,000 for a down payment and the $100,000 line is crossed. The full forgone interest now counts as income to the parent every year, whether or not a dollar changes hands. At that point charging the AFR is cheaper than not charging it.
Wondering how much you can realistically lend?
The same affordability math a bank runs works just as well on a family deal. See how borrowing limits are calculated →
7. What a $50,000 family loan really costs
Quick Answer: On $50,000 over five years, a bank loan at the 11.86% average costs $16,521 in interest. Priced at the 4.35% mid-term AFR it costs $5,725. The family version saves about $10,800, and still pays the lender more than a savings account would.
The same $50,000, three ways. Bank pricing uses the Federal Reserve’s average 24-month personal loan rate; the family rows use August 2026 AFR figures.
| How it is priced | Monthly payment | Interest over 5 years | Relative cost |
|---|---|---|---|
| Bank personal loan, 11.86% | $1,108.69 | $16,521 | |
| Family loan at mid-term AFR, 4.35% | $928.74 | $5,725 | |
| Family loan at 0% | $833.33 | $0 paid; about $5,438 forgone |
Modeled projection by DollarVisor, August 2026. Bank rate: Federal Reserve G.19, 24-month personal loans at commercial banks, Q2 2026. AFR: Revenue Ruling 2026-13. Bars show interest relative to the bank loan.
Two things stand out. The AFR version is no token rate: the lender collects $5,725, more than most savings accounts would pay over five years. And the 0% version is not free: it moves $5,438 from a payment schedule into forgone interest, the number the tax rules are built around.
One line is missing from all three rows: an origination fee. Family loans do not carry one, which widens the gap on smaller amounts. Our breakdown of APR versus interest rate explains why a bank’s headline number understates its real cost.
8. What happens if they stop paying
Quick Answer: Three exits: renegotiate, forgive, or write it off. A forgiven family loan is a gift and counts against the $19,000 annual exclusion. A genuinely uncollectable one can be deducted as a nonbusiness bad debt, but only if it was documented as a loan from day one.
Ranked by cost to you:
- Rewrite the schedule. Lower the payment, extend the term, sign an amendment. No tax event occurs. If the borrower is juggling debts, the snowball or avalanche payoff order matters more than this rate.
- Forgive part or all of it. The forgiven amount is a gift that year. Under $19,000 per person it never reaches a tax return, and larger balances can be forgiven in yearly slices under the line.
- Claim a bad debt deduction. The IRS treats a totally worthless nonbusiness debt as a short-term capital loss on Form 8949. Partial worthlessness does not qualify, and you must attach a statement covering the debt, the debtor and your collection efforts.
That last requirement is why the note matters more than any lawsuit. You must show you intended a loan, not a gift, and a signed agreement with a schedule is the evidence. There is also a clock: every state limits how long a written contract stays enforceable, the same rule behind the statute of limitations on debt.
A family loan never shows up on a credit file. Nothing is reported, so unlike the way personal loans affect your credit, on-time payments build no score and a default damages only the relationship.
9. How to set up a family loan, step by step
Quick Answer: Agree the amount and end date, look up that month’s AFR, check your state ceiling, write the note, transfer the money by bank record, then log every payment. Six steps and one afternoon.
- Agree the amount and maturity date. The end date decides which AFR tier applies, so settle it first.
- Look up the AFR for the month you sign. Use the tier matching your term and compounding period.
- Check your state’s usury ceiling. Confirm your rate sits below the local maximum, as low as 6% in Pennsylvania.
- Write the note and both sign it. Use the eight-item checklist above, and attach an amortization schedule.
- Move the money so it leaves a record. Transfer or check, never cash, referencing the note in the memo.
- Log every payment. Date, amount, and the principal/interest split. The lender reports that interest yearly.
Skipping step five is the most common failure. Cash leaves no proof the money moved, undoing every other step.
10. Conclusion
Quick Answer: Write it down, price it between the federal floor and your state ceiling, and move the money by transfer. Under $10,000 the tax rules are off; over $100,000 they are fully on. In between, the borrower’s investment income usually keeps the bill at zero.
A family loan is cheap because no lender takes a margin, not because the rules are looser. The floor comes from the IRS, the ceiling from your state legislature, and both are published numbers you can check in ten minutes.
The paperwork is worth more than the interest. A family loan agreement turns an awkward conversation into a debt, and a bad year into a deduction rather than a loss. If your state’s corridor is too tight, weigh it against the lending options we track, including the ones we steer people away from, like loans marketed without a credit check and car title loans.
11. Frequently asked questions
Does a family loan agreement have to be in writing?
Practically, yes. Without a written note you cannot prove the transfer was a loan rather than a gift, cannot claim a bad debt deduction if it goes unpaid, and have no agreed schedule. A one-page note signed by both parties solves all three.
What interest rate should a family loan charge?
At least the Applicable Federal Rate for the month you sign and the term you chose. In August 2026 that is 4.10% up to three years, 4.35% out to nine years, and 4.92% beyond, compounded annually. Then confirm it sits under your state’s usury ceiling, as low as 6% in Pennsylvania.
Can you lend money to family interest-free?
Yes. Below $10,000 the below-market loan rules do not apply. Between $10,000 and $100,000 the imputed interest is capped at the borrower’s net investment income, and treated as zero if that income is $1,000 or less. Above $100,000 it is reportable income for the lender.
Is a family loan considered a gift by the IRS?
Not if it is documented and repaid on a schedule. It becomes a gift in two cases: charging below the Applicable Federal Rate, which makes the forgone interest a gift, and forgiving the balance. Either way, up to $19,000 per recipient in 2026 needs no gift tax return.
What happens if a family member never repays the loan?
Rewrite the schedule, forgive the balance, or claim a nonbusiness bad debt. Forgiveness is usually simplest, because the annual exclusion absorbs most family-sized amounts. A bad debt deduction needs the debt to be totally worthless and reports as a short-term capital loss on Form 8949.
Before you lend, see what the alternative costs.
We compare banks, credit unions and online lenders with state-level numbers and no paid placement, so you can tell whether a family loan is really cheaper.
This article is information, not financial, tax or legal advice. Figures are accurate as of August 2026 and change over time. See our disclaimer.