How to Properly Loan Money to Your Child for a House Down Payment

Helping your child buy a home is one of the more meaningful financial gifts a parent can give. But when the help comes in the form of a loan rather than a gift, the way you document it matters more than most families realize. A handshake arrangement between parents and children sounds fine until a divorce, a bankruptcy, a sibling dispute, or a mortgage application reveals exactly how much trouble an undocumented family loan can create.

Here is how to do it right from the start.

Decide Whether It Is a Loan or a Gift Before You Do Anything Else

This sounds obvious but it is where most families go wrong. The intention at the start is usually clear: it is a loan, the child will pay it back. But the documentation does not reflect that, payments never really start, and years later the nature of the transaction is genuinely murky.

A loan and a gift have different legal and tax implications, and the mortgage lender your child is working with will want to know which one it is. If it is a gift, the lender will typically require a signed gift letter confirming no repayment is expected. If it is a loan, it will be counted as a liability on your child's debt-to-income ratio, which affects how much mortgage they can qualify for.

Make the decision clearly, communicate it to everyone involved, and document it accordingly. Do not call it a gift for the mortgage lender and then expect repayment later. That creates legal exposure for everyone.

Use a Promissory Note to Document the Loan

If the arrangement is genuinely a loan, a signed promissory note is the document that makes it real. The note should state the principal amount, the interest rate, the repayment schedule, what happens if a payment is missed, and both parties' names and signatures.

A note scribbled on paper or a text message saying "I'll pay you back" is not sufficient. Courts have seen enough family loan disputes to be skeptical of informal arrangements, and the IRS has its own reasons to scrutinize undocumented transactions between relatives.

Charge at Least the Applicable Federal Rate

For family loans above $10,000, the IRS requires a minimum interest rate equal to the Applicable Federal Rate, or AFR. The IRS publishes updated AFR tables monthly, and the rate varies depending on whether the loan term is short-term, mid-term, or long-term.

If you charge below the AFR or nothing at all on a loan above $10,000, the IRS treats the difference as imputed interest. You are taxed on interest income you never actually received, and the forgone interest may be treated as a taxable gift to your child. For loans above $100,000, additional rules apply depending on your child's net investment income.

Charging the AFR is usually a low rate, often well below market, and it satisfies the IRS requirement while keeping the loan genuinely affordable for your child. Check the current AFR tables before finalizing the note and build that rate into the document.

Set Up a Real Repayment Schedule and Stick to It

The IRS and courts both look at whether a family loan functions like a real loan or whether it is a gift with paperwork attached. The single biggest factor that distinguishes the two is whether actual payments are being made.

Set a repayment schedule in the promissory note that reflects genuine expectations. Monthly installments work well because they create a consistent paper trail. The payments do not need to be large, but they need to happen on a regular basis and be documented. Your child should make payments by check or bank transfer, not cash, so there is a clear record. Keep a log of every payment received, including the date and amount.

If you eventually decide to forgive part or all of the remaining balance, you can do that as a gift at that time, up to the annual exclusion limit of $18,000 per person in 2024 without triggering gift tax filing requirements. But start with the structure of a real loan and make adjustments later rather than treating it as a loan on paper while functioning as a gift from day one.

Understand How It Affects Your Child's Mortgage Application

If your child is taking out a mortgage to buy the home, the lender will review their financial picture carefully. A documented loan from a parent counts as a liability and gets factored into the debt-to-income calculation. Depending on the monthly payment amount and the size of the mortgage they are applying for, this could affect their ability to qualify.

Some families time the loan to allow a seasoning period before the mortgage application, meaning the funds have been in the child's account long enough that the lender treats them as existing assets rather than a new debt. Mortgage lenders typically look back two to three months on bank statements. Talk to your child's mortgage broker or lender before structuring the loan so you understand how the timing and documentation will be treated.

Consider What Happens If Your Child Gets Divorced

This is the conversation no family wants to have, but it is one worth having before money changes hands. In a divorce, assets and debts accumulated during the marriage are typically subject to division. A down payment loan from a parent with clear documentation as a loan, rather than a gift, is more likely to be treated as a marital debt that both spouses share responsibility for rather than as an asset the divorcing spouse gets to keep half of.

The specifics depend on your state's divorce laws and how the property was titled, but having a formal promissory note is significantly better protection than an informal arrangement. An attorney familiar with family law in your state can walk you through how a documented parental loan would likely be treated in a dissolution proceeding.

Think Through the Sibling Equity Question

If you have more than one child, a loan to one of them that is later forgiven can create real tension around estate planning. The child who received and never repaid a $50,000 down payment loan effectively received an advance on their inheritance, while siblings who did not need that help received nothing equivalent.

Some parents address this explicitly in their estate documents, noting that loans made to specific children will be counted against their share of the estate. Others prefer to keep things separate. Either approach can work, but leaving it unaddressed and undocumented is what leads to sibling disputes after you are gone. Your estate attorney can help you think through how to handle this consistently across your children.

Keep Copies of Everything

Store the signed promissory note somewhere safe and make a digital copy immediately. Keep records of every payment made, every communication about the loan, and any modifications to the terms. If the loan is ever forgiven in whole or in part, document that in writing too with a signed release or modification agreement.

Family loans have a way of becoming disputed years later when circumstances change, memories fade, and the people involved have different financial stakes in how the transaction gets characterized. A clean paper trail protects everyone, including your child, from having to reconstruct the details of a transaction that happened years earlier under pressure.

A Loan Done Right Protects the Relationship

Lending money to a child is an act of generosity, and doing it with proper documentation is not a sign of distrust. It is what keeps the arrangement from becoming a source of tension, confusion, or conflict down the road. A signed promissory note, real payments, and clean records mean everyone knows where they stand, and that clarity is what lets the relationship stay focused on the relationship rather than the money.