How to be the Bank of Mom and Dad: Funds, Terms, and Estates
So you’ve decided you want to become the Bank of Mom and Dad. Fortunately, you don’t have to register with the state or federal government. However, there are some important considerations you should address.
This is Part 2 of the Bank of Mom and Dad Series.
Part 3: The Bank of Mom and Dad: FAQ and Closing Thoughts – Gilbert Wealth
The Best Sources of Funds
Before you act as a lender, assess how the loan fits into your own financial plan. To fund the loans to your children or other family members, you need ready access to the money without significant costs to you. Sources might include:
| Source | Cost | Explanation |
| Cash, Checking, Savings | Opportunity | Using cash reduces your liquidity and foregoes any potential investment returns that cash might earn elsewhere. |
| Money Markets | Opportunity | While low risk, redeeming money market funds gives up modest interest earnings and reduces short-term reserves. |
| High Basis Investment Account | Opportunity | Selling appreciated but high-basis assets avoids capital gains tax but loses future growth potential and possibly dividends or interest. |
| Cash Value Life Loans | Opportunity and Financial | Reduces policy value and potential death benefit; interest accrues on the loan and may need to be repaid to avoid policy lapse. |
| Margin Balance on Investments | Financial | Interest on margin loans can be high and variable; increases risk of margin calls and impacts overall portfolio stability. |
| 401k Loan | Opportunity and Tax | Repayments are made with after-tax dollars; missed payments may result in penalties, and funds miss out on market growth while withdrawn. |
| HELOC | Financial | Interest payments can vary; adds debt secured by your home and may reduce borrowing capacity for future needs or emergencies. |
While there are many potential sources of funds, most options beyond cash, liquid investments, or credit lines carry significantly higher costs or long-term trade-offs. Tapping low-basis taxable accounts, IRAs, annuities, or real estate can trigger taxes, penalties, or transaction fees, while draining Roth IRAs or life insurance policies undermines valuable tax-advantaged growth and future security. Even seemingly accessible assets like CDs or bond ladders may result in opportunity loss or early withdrawal penalties. These sources are generally less ideal for funding family loans due to their complexity, cost, and potential to disrupt long-term financial goals, and should be considered only after evaluating more efficient alternatives.
Loan Terms and Documentation
Just as a bank requires paperwork to obtain a loan, you too should have documentation in place the outlines the following:
- Loan Amount and Date of Loan
- Interest Rate (See below on interest rate considerations)
- Loan Length: For example, 6 month, 5 years, 15 years, etc
- Payment Schedule: Monthly, Quarterly, Balloon Payment, or Interest Only.
- Late Payment Terms: If there are fees or grace periods.
- Collateral: If there is collateral put up for the loan.
Ideally, you’ll also have an amortization schedule showing payments over the term of the loan to properly document payments and interest.
Interest Rate
The interest rate is arguably the most important term here as the interest rate chosen dictates whether the loan amount is considered a gift or not. The IRS will treat a loan as a gift instead if the interest is below the published Applicable Federal Rate (AFR). The AFR is used for a variety of calculations but for the purposes of family loans, you are concerned with the standard AFR. Depending on the length of your loan, you’ll also need to select the appropriate rate based on if the loan is short term (less than 3 years), medium term (3 to 9 years), and long term (9+ years).
For example, let’s assume you are loaning money for a car. To simulate a market car loan, you loan your child $15,000 with a standard repayment period of 60 months or 5 years payable monthly. As of this writing, the current AFR in May 2025 for a mid-term loan is 4.03%. So if you set the interest rate above 4.03%, the loan will not be considered a gift. If you set the loan below 4.03%, you will need to begin to consider gift tax considerations.
For contrast, as of the time of the writing, the average commercial auto loan rate for a new car is around 6.35%.
See Applicable Federal Rates | Internal Revenue Service for the latest rates.
Estate Planning Considerations
Family loans interact with your estate plan in several key ways:
Outstanding Loan as Estate Asset
If you die with the loan unpaid, it becomes part of your estate. You can specify whether to forgive it in your will or count it against the beneficiary’s share. Your Last Will and Testament and/or Trust should clearly state the options available at that time so there is no confusion.
Ideally, you should store the latest balance and amortization schedule along with your estate documents.
Equalization Among Siblings
If one child receives a loan, other heirs may expect “equal treatment.” You can address this by:
- Making similar loans or gifts to others.
- Reducing the indebted child’s inheritance by the unpaid balance.
- Treating it as an advancement against their inheritance.
Gift Taxes
If you recorded gift returns in the past, ensure these are accounted for.
Taxes
Maintain payment records and promissory notes. There are two main tax considerations here:
- Interest Charged: Any interest charged is taxed at your ordinary income tax rates. These interest payments are easily identified in your amortization schedule
- Imputed Interest: If you charge below the IRS AFR rates (see above), you will need to account for imputed interest and record that appropriately. You are not taxed on the imputed interest but if your total gifts plus the imputed interest is greater than your annual exclusion, you may need to file IRS Form 709 for gift taxes. See Gifting and the Annual Exclusion – Gilbert Wealth