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To avoid paying additional interest on my student loans, I want to ask my mother to pay off the entire loans with by lump sum, and then I would pay her back with interest.

Are there any issues regarding taxing for this?

(In NJ)

  • 1
    What's the total? Just to make sure you're within gift allowances. – corsiKa Feb 15 at 0:47
  • Are they federal student loans? – trognanders Feb 15 at 5:53
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    I don't know anything about the tax. I just know that loans between family members can be a huge source of anger, frustration and ultimately breakup. Just watch any episode of Judge Judy. – chasly from UK Feb 15 at 20:47
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    ...so you're still paying interest? Seems like you just want a more lenient lender (not saying it's a bad idea...except it's a bad idea [for mom]) – NKCampbell Feb 15 at 21:09
  • @corsiKa The gift allowances don't apply to what's being asked. The OP isn't saying this is a gift. If it was a gift, then the mother would pay off the loan and there would be no repayment to her by the OP. What the OP has described is getting a loan from their mother that is used to pay off the student loan debt. Alternately, it could be looked at as the mother buying the loan from the current owner of the debt. There could be issues if both parties don't treat it as an actual loan, or if the interest paid to the mother isn't equivalent to what would be the market rate. – Makyen Feb 16 at 0:26
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In the US, the main tax consequences are:

  • The interest she receives will be income and have to be declared as such
  • The interest you pay would no longer be deductible since loans from relatives are not eligible student loans
  • If she charges you interest less than the "market rate" (roughly 2-3% right now depending on the term of the loan), the difference in the interest you pay versus what you would pay at market rates can be classified as a gift and taxed accordingly.

So IF you decide to do this, my suggestions would be:

  • Get everything in writing - the interest rate, term, payment structure, etc.
  • Use a "fair" interest rate - this is to both be fair to her for giving you money instead of investing it, and avoids the tax consequences above.
  • Set up a reasonable time frame - don't extend the loan to 30+ years.
  • Pay it off as soon as you possibly can (for your benefit and hers).
  • In this context, treat her like a bank. Don't take advantage of your relationship to be late on payments, skip payments, etc. (without agreement in writing up front).

THAT SAID, loans from family can be problematic. They can taint relationships, make you think about each other differently (will you tell her about your extravagant vacations when you owe her money?) and if things don't go to plan it can actually ruin relationships. You also might want to make sure your siblings (or any other heirs) are aware of the arrangement since it affects their inheritance if she passes. An unsecured loan can be even more risky, since there's nothing that she can take to compensate her if you decide not to pay the loan (unlike a mortgage or a car loan). But if you're willing to take that risk, paying interest to family is better than paying it to a bank.

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    Regarding the "gift", there is an 11million lifetime exemption. In other words: for the 99.999% of the people gifting significant amount of money is no issue at all and does not require paying any gift tax but only documenting the gift if it exceeds 15K in a given year. – Bakuriu Feb 14 at 21:59
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    And your mother can still gift you the interest or forgive any or all of the debt if she wants to. So formalizing it in this way doesn't prevent her from treating it more informally if she wishes to. It just ensures that everything is as clear as possible should there ever be any issues. – David Schwartz Feb 14 at 22:24
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    I disagree with the last statement that "paying interest to family is better than paying it to a bank." If family withdraws funds from an investment that pays 10% annual returns to pay down a debt that charges 7% and gives large tax breaks on interest paid, the entire family will be wealthier in the long run if you pay those loans to the bank and take the tax deductions while the investment grows. – Glen Pierce Feb 14 at 23:34
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    "loans from family can be problematic. They can taint relationships" My first thought also. If you pay her no interest she will actually loose money due to inflation. – Kjetil S. Feb 15 at 11:54
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    As Patrick Rothfuss put is so well: "There are two sure ways to lose a friend, one is to borrow, the other is to lend." Aside from tax complications you should consider twice before mixing monetary and personal relationships - even if you try to strictly keep those things separate, things WILL bleed over no matter what. (I speak from experience: I lent a close relative a non trivial sum; they have fallen on hard time and are willing-but-unable to repay at the moment. I am supportive, understand the situation and fortunately do not need the money right now, but still it left a slight sourness.) – CharonX Feb 15 at 12:24
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Just to provide some numbers and math:

  • The gift tax exclusion in 2019 is $15,000.
  • If your mother is married (to your father or someone else), she can provide the funds for each to give up to $15,000. So $30,000 total.
  • If you are married, you and your spouse can each receive a $15,000 gift from each relative. So $30,000 (mother's not currently married) or $60,000 (mother married) total.
  • If the amount is over that, it goes against the estate tax exclusion. That's constantly changing, so I won't document the current amount. But if you do not expect to inherit millions from your mother, then it probably doesn't matter.
  • If your mother is charging you below market rate interest on a loan, you only have to figure gift tax on the interest that you would have paid. Not on the loan.
  • The IRS publishes rates. The current rate is somewhere between 1.93% and 2.91%.
  • If we assume a 3% rate (higher than what the IRS posted), then to go above $15,000 in interest, the loan would have to be at least $500,000. That's rather large for a student loan.

    Principal = Interest * 100% / Rate
    $500,000 = $15,000 * 100 / 3

Substitute as necessary.

Gift tax is unlikely to be a problem unless you are also receiving some other gift from your mother.

For others who may come here, you can entirely avoid this if you are under twenty-five and your mother simply pays for your education. Paying for education directly is just a normal parental activity. No gift tax would apply.

I will skip the question of whether it is a good idea to borrow money from family, but I agree that it can be problematic.

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I am a parent. I have learned two things: 1) never cosign EVER. 2) never lend money. Instead, I give whatever money I can afford to give with the clear direction that it is not a loan. This has come about because for 100% of the things I have co-signed, the other person did not make the payments. For 100% of the loans I have personally given, the other person has not paid me back. Nor have I witnessed, in the rest of my family, that there is an exception. As you say, it taints.

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    Please elaborate on the answer to the question asked (which was "Are there any issues regarding taxing for this?") – Joe S Feb 15 at 19:32
  • I'm sorry. I have loaned to others and recovered at a really good percentage. You've had it rough. – Joshua Feb 16 at 4:04
  • A slightly more moderate view would be don't loan money in the family unless you are prepared to forgive the debt. That still has the relationship problems. – o.m. Feb 16 at 19:54

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