A family mortgage is a home loan made between relatives, where one family member lends another the money to buy a house and the loan is secured by the property itself. The IRS treats it like any other mortgage, but only if you follow a few specific rules: charge at least the Applicable Federal Rate, sign a real promissory note, and record a mortgage or deed of trust with the county. Do those things and the borrower keeps the mortgage interest deduction, the lender earns a modest return, and the family skips the origination fees, private mortgage insurance, and other closing costs that come with a bank loan.
How a Family Mortgage Works
The most common setup is straightforward. One relative writes a check for the purchase price (or a share of it), and the borrower signs a promissory note and a mortgage or deed of trust, exactly as they would with a bank. The lending relative sets the term, collects monthly payments, and holds a security interest in the home.
Because no bank sits in the middle, both sides get flexibility. You choose the interest rate (within IRS limits), the length of the loan, and how to handle life events like a job loss or an early payoff. That flexibility is the draw. The tradeoff is that the family is now responsible for the paperwork, the tax reporting, and the awkward conversations if payments stop coming.
The IRS Minimum Interest Rate
The IRS won’t let families disguise gifts as interest-free loans. Any private loan charging less than the Applicable Federal Rate is a “below-market loan,” and the gap between what you charged and what you should have charged is treated as if the lender gave the borrower a gift and the borrower paid it back as interest.1Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates That phantom interest becomes taxable income to the lender even though no cash changed hands.
The AFR varies by loan length. Loans of three years or less use the short-term rate, loans over three years through nine years use the mid-term rate, and loans over nine years use the long-term rate.2Office of the Law Revision Counsel. 26 USC 1274 – Determination of Issue Price in the Case of Certain Debt Instruments Issued for Property Most family mortgages run 15 or 30 years, so the long-term rate is usually what applies. For February 2026, the annual-compounding AFRs are 3.56% short-term, 3.86% mid-term, and 4.70% long-term.3Internal Revenue Service. Rev. Rul. 2026-3 – Applicable Federal Rates for February 2026 The IRS publishes new rates monthly. Lock in the rate for the month you fund the loan and write it into the promissory note; on a fixed-rate term loan, that rate holds for the life of the loan.
Nothing stops you from charging more than the AFR, and many families do. Splitting the difference between the AFR floor and prevailing bank rates gives the borrower a real discount while paying the lender more than a savings account would.
When Smaller Loans Are Exempt
Not every family loan triggers the below-market interest rules. Two carve-outs exist, though neither will cover a typical home purchase.
If the total you’ve lent a family member stays at $10,000 or less on any given day, the imputed interest rules don’t apply, and you can charge zero interest without tax consequences. That exception disappears if the borrower uses the money to buy income-producing assets like rental property or stocks.1Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates
For loans between $10,001 and $100,000, the imputed interest the lender must report can’t exceed the borrower’s net investment income for the year. If that net investment income is under $1,000, the IRS treats it as zero, and no imputed interest applies.4GovInfo. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates Useful for down payment help or a renovation loan; not useful for a full home purchase, which will almost always run past the $100,000 cap.
Gift Tax Exposure
When a family mortgage is priced below the AFR, the forgone interest is treated as a gift. If the imputed gift to one recipient exceeds $19,000 in 2026, the lender has to file a gift tax return on Form 709.5Internal Revenue Service. Gifts and Inheritances 1 A married couple electing gift-splitting can give up to $38,000 per recipient before the filing requirement kicks in.
Filing doesn’t automatically mean owing. The federal lifetime gift and estate tax exemption is $15,000,000 per person for 2026, so most families never write a check for gift tax.6Internal Revenue Service. What’s New – Estate and Gift Tax But gifts above the annual exclusion eat into that lifetime exemption, reducing what will eventually be sheltered from estate tax. Charging at least the AFR avoids the issue.
Documents You Need
Two documents make a family mortgage real: the promissory note and the mortgage (or deed of trust, depending on your state). Treating either as optional is the most common mistake families make. Without them, the IRS can reclassify the whole transaction as a gift, and the borrower loses the interest deduction.
The promissory note is the borrower’s personal promise to repay. It sets the loan amount, interest rate, monthly payment, due dates, maturity date, and what counts as default. A good note also covers late fees and prepayment rights. A late-fee provision in the range of 4% to 5% of the overdue installment is typical and signals that both parties treat the loan seriously.
The mortgage or deed of trust attaches the loan to the property and gives the lender the right to foreclose if the borrower stops paying. It needs a legal description of the property (parcel number and boundary description from the deed, not just the street address) and the full legal names of both parties as they appear on government ID. Both documents should reference the interest rate and confirm it meets or exceeds the AFR in effect on the funding date.
A real estate attorney can draft these for a few hundred dollars. Online templates exist, but quality varies, and they may not comply with your state’s recording rules.
Recording With the County
After signing, the mortgage or deed of trust has to be notarized and filed with the county recorder or registrar of deeds. Recording does two jobs. It puts the world on notice that the lender has a claim against the property, and it satisfies the IRS requirement that the debt be “recorded or otherwise perfected” so the borrower can deduct the interest.7Internal Revenue Service. Publication 936 – Home Mortgage Interest Deduction Skip recording and the borrower cannot claim the mortgage interest deduction.
Recording fees vary widely by county. Some jurisdictions charge a flat fee, others charge per page, with base fees typically running from under $20 to over $100. A handful of states add a mortgage recording tax based on the loan amount. Notary fees are modest, generally under $25 per signature. Once recorded, the county returns a stamped or sealed copy. Keep it with the loan file for any future refinance, sale, or audit.
Tax Reporting Each Year
Both parties have annual reporting to do, and this is where families often stumble.
The Lender
Interest you receive is taxable income. Report it on Schedule B of Form 1040, listing the borrower’s name, address, and Social Security number.8Internal Revenue Service. Instructions for Schedule B (Form 1040) If you charged below the AFR, report the imputed interest as income too, even though you never collected it.9Internal Revenue Service. Publication 550 – Investment Income and Expenses
A common misconception: private family lenders are not required to issue Form 1098. That form is for parties receiving mortgage interest in the course of a trade or business, and a parent lending a child money doesn’t meet that standard.10Internal Revenue Service. About Form 1098 – Mortgage Interest Statement Schedule B still applies; the 1098 does not.
The Borrower
The borrower can deduct interest paid on a family mortgage the same way they’d deduct interest on a bank loan, but only if the loan is a secured debt recorded or otherwise perfected under state law.7Internal Revenue Service. Publication 936 – Home Mortgage Interest Deduction An unrecorded handshake loan does not qualify, regardless of how regularly payments are made. The borrower also has to itemize on Schedule A to get the benefit. With no Form 1098 arriving, the borrower reports the interest directly on Schedule A along with the lender’s name, address, and taxpayer identification number.
Planning for Default, Forgiveness, and the Lender’s Death
Lending money to family is the easy part. The hard part is what happens when payments stop, when a lender wants to forgive part of the balance, or when the lender dies with a note outstanding. Address these in advance.
If the borrower stops paying, a properly recorded mortgage gives the lender the same rights a bank would have, including the right to initiate foreclosure. State law controls the procedure, and federal rules bar foreclosure from starting until payments are more than 120 days past due. Most families never get near foreclosure, but having the mechanism spelled out in writing pushes both sides to renegotiate before things fall apart.
When a family lender forgives part or all of the balance, the borrower generally does not owe income tax on the canceled amount, because gifts are excluded from gross income.11Internal Revenue Service. Publication 4681 – Canceled Debts, Foreclosures, Repossessions, and Abandonments The forgiven amount does count as a gift from the lender, though. Forgiving a $200,000 balance in a single year blows past the $19,000 annual exclusion and consumes a chunk of the lifetime exemption. Some families forgive the balance in yearly increments that stay within the annual exclusion, though that approach takes planning and consistency.
The note doesn’t vanish when the lender dies. It’s an asset of the estate, valued generally at unpaid principal plus accrued interest, and it passes to whoever inherits it under the will, trust, or state intestacy rules. The new holder can keep collecting, modify the terms, or forgive the balance, subject to the same gift tax rules. Naming a successor holder in the original documents, or directing the note into a trust, spares the borrower from waiting on a probate court if payment terms need to change. For families with estates approaching the $15,000,000 lifetime exemption, forgiving a large balance before death (as a gift) may produce a better tax result than letting the full face value sit in the taxable estate.6Internal Revenue Service. What’s New – Estate and Gift Tax
Using a Loan Servicer
Many families hire a third-party loan servicer to handle payment collection, send monthly statements, and track the amortization schedule. A servicer creates a paper trail that looks identical to a conventional mortgage, which is exactly what you want if the IRS ever questions whether the loan is real. It also spares a parent from chasing a child for a late payment.
Fees for servicing private notes are usually modest, often a small monthly flat charge or a percentage of the remaining principal. The servicer produces year-end statements showing total interest paid and principal remaining, which both sides need for their tax returns. Some servicers also handle escrow for property taxes and insurance for an additional cost. Even without a servicer, keep detailed records of every payment: date, amount, and the split between principal and interest. The IRS expects the same documentation from a family mortgage that it would from a bank loan.