Down Payment Loan From Parents to a Homebuyer
Parents helping with a down payment is one of the most common (and most quietly mishandled) family loans. The mortgage lender, the IRS, and the family relationship each pull in a different direction. Picking the right structure up front avoids the worst outcome: a loan that is fraud to the lender, a gift to the IRS, and a fight at Thanksgiving.
The three options and what each one means
Pure gift. Parents give the money and do not expect repayment. Documented with a gift letter the lender requires. No promissory note. Donor files IRS Form 709 if total gifts exceed the annual exclusion ($19,000 per donor per recipient in 2026).
Pure loan. Parents lend the money. Buyer signs a promissory note at the AFR. Buyer\'s debt-to-income ratio includes the monthly payment. The mortgage lender must approve the loan and may require seasoning or subordination.
Mixed. A portion is documented as a gift (within the annual exclusion or with Form 709 filed), and a portion as a loan. Each is treated separately by the lender and the IRS.
The mortgage lender\'s gift letter
A typical gift letter requires the donor to state:
- The exact amount being gifted
- That the money is a gift, not a loan
- That repayment is not expected, in any form
- The donor\'s relationship to the buyer (parent, grandparent, etc.)
- The source of the funds
Submitting a gift letter when you actually expect repayment is mortgage fraud and a federal crime. If you want a real loan, do not sign the gift letter.
How a real loan affects the buyer\'s mortgage approval
The mortgage underwriter calculates debt-to-income (DTI) using all monthly debt obligations. Adding a $400/month parental loan payment can push DTI past the cap (43% for most conventional loans, sometimes higher for jumbo or low-DTI programs).
Three ways to manage this:
- Structure the parental note as long-term (30 years) with a low payment
- Use an interest-only or graduated note that starts low and steps up
- Use a "balloon" note where small or zero payments are made now, principal due at sale of the home or in 5+ years
Whatever you choose, the lender must see the full note and run DTI on the actual payment.
The Applicable Federal Rate (AFR)
The IRS publishes minimum interest rates each month. For a loan over 9 years (typical for home down-payment notes), use the long-term AFR. Charging less than AFR triggers:
- Imputed interest income to the parent (parent reports interest as if AFR was charged)
- Imputed gift to the buyer (the difference between AFR and what was charged)
For a $50,000 loan at the long-term AFR (often 4 to 5 percent in normal rate environments), the parent reports about $2,000 to $2,500 of interest income per year.
The $10,000 de minimis exception
Below $10,000, intra-family loans escape AFR rules entirely (no imputed interest, no gift treatment) as long as the loan is not used to buy income-producing property. A $10,000 down-payment loan to a child can be 0 percent. A $50,000 down-payment loan cannot.
Secured vs unsecured
Most parental down-payment loans are unsecured. Recording a second mortgage in favor of the parents has advantages:
- Priority over later creditors of the buyer
- Bankruptcy protection for the loan
- Documentation that the IRS treats as a real loan
And disadvantages:
- The primary mortgage lender must approve and subordinate
- Recording fees
- The buyer cannot refinance later without the parent signing off
What to put on the promissory note
- Principal amount
- Interest rate (at or above AFR for the term)
- Payment schedule (monthly amortizing, interest-only, or balloon)
- Maturity date
- Whether secured (lien on home) or unsecured
- Late fee and grace period
- Acceleration on default
- Prepayment without penalty
- Governing state law
- Signatures
What if the parents want to forgive the loan later?
Forgiving principal is treated as a gift in the year it happens. Parents can forgive up to the annual exclusion per child per year without filing Form 709. A $50,000 loan forgiven over 5 years at $10,000 per year per parent (married couple, $40,000 per year) is fully gift-tax-exempt.
If the loan was secured by a recorded mortgage, file a release of mortgage when the loan is forgiven or paid off.
The Thanksgiving test
Whatever structure you pick, write it down on the day the money moves. A conversation in the kitchen does not survive 10 years and a divorce. A signed note kept in two places does. Family loans go bad most often because no one wrote down what was actually agreed.