Is There a Minimum Interest Rate for A Seller Financing Loan?
The answer is YES!
There is what is called the minimum Applicable Federal Rate (AFRs) which is sometimes called the “arm’s length” rate.
This is the minimum interest rate that a private lender can give without violating federal law. The law is put in place to prevent people from “gifting” assets to others (usually family) by calling it a loan with a 0% (or incredibly low) interest rate.
This would effectively allow someone to transfer wealth while avoiding gifts or transfer tax. Therefore, the federal government created the AFR in the Tax Reform Act of 1984.
AFRs are These rates change over time (as all federal rates do) so you need to check in before creating any seller financing loans.
This concerns you if you are getting (or giving) private loans. If you get a loan or seller financing with an interest rate below the AFR, the IRS may consider that a gift and not a loan. The lender may be charged punitive fees and may be charged an income tax.
This could have terribly negative consequences for you and your lender. You need to consult with an accountant and visit the IRS website for updated minimum rates. This will keep you and your lender in compliance with this tax code and help avoid any unnecessary lender surprises.
For more information like this check out my blog at www.realestateraw.com and join my Facebook group Real Estate Raw for Multifamily Investors.
Best of luck!
Bill Ham