The Bank of Mom and Dad: FAQ and Closing Thoughts

When a child cannot repay the loan, it can be very difficult for you and for them. No one likes to put other people in difficult situations, particularly when they are your parents. 

Talk about this scenario in advance. Address it in the loan agreement if possible, and have a plan for how it might affect family dynamics and finances.

You have a few options to consider:

• Restructure the loan with a lower payment, interest-only terms, or a longer period.
• Forgive some or all of the loan. Keep in mind that forgiveness may count as a gift for tax purposes and could require a gift tax return if it exceeds the annual exclusion amount.
• Offset against inheritance by reducing their future estate share by the unpaid balance.

Approach the situation with grace and communicate openly throughout the whole process.

In bankruptcy, family loans are generally treated like any other unsecured debt—meaning you could be repaid very little, or nothing at all. Bankruptcy courts often scrutinize insider loans (i.e., between family members), especially if they appear informal.

• If the loan is documented properly (with a promissory note, payment history, and terms), you can file as a creditor in the bankruptcy proceeding.
• If it’s not documented, it may be treated as a gift or dismissed entirely.
• Securing the loan with collateral (like a lien on a home or car) can offer protection, but requires legal setup in advance.

Yes, but with caution. You will need to be careful not to violate rules regarding the IRS “Transaction Doctrine” which may cause the entire loan to be counted as a gift. This rule basically gives the authority to the IRS to ignore intermediary steps taken to get to a result if those steps were purely done to sidestep existing rules. 

For example, if you set up a loan for $100,000 with a child and then forgive the maximum annual allowance each year until the loan is forgiven, that likely violates the rules and the full $100,000 will be counted as a gift in the year gifted.

The original loan must be made with a full intent for the child to repay the loan. In documentation and actions to repay, the loan needs to look like a traditional loan with a repayment schedule. 

Yes, if you want to avoid IRS scrutiny. The IRS requires you to charge at least the Applicable Federal Rate (AFR). If you charge less or no interest, the IRS may “impute” interest—treating the loan as partially a gift.

Interest you receive must be reported on your tax return as income.

If your financial situation changes and you need repayment faster:

• Discuss your situation with your child and see if they are able to obtain a third party loan so they can repay your loan.
• You can ask to renegotiate the terms, but your child is not legally required to agree unless the contract allows acceleration.
• Consider including a clause in the agreement allowing for early repayment upon notice.

You don’t have to—but it’s highly recommended for larger loans or complex terms. This does add cost to the loan which should be considered before proceeding. 

A lawyer can:

• Draft a legally enforceable promissory note.
• Help structure terms that won’t violate tax or estate laws.
• Guide you through repayment scenarios or enforcement issues.

A loan servicing company can:

• Automate billing and payments.
• Send year-end interest statements.
• Provide third-party documentation, helpful for audits or disputes.

There are a few tools out there that may make family loans easier. This is not an endorsement of them and they are presented in no particular order – just an idea that these services exist should you be interested:

Loan Management

• National Family Mortgage
• ZimpleMoney.com
• LoanBack

Templates and Document Creation

• Rocket Lawyer
• Nolo.com
• LegalZoom