Personal Loan vs. Borrowing From Family

The two tools side by side

A family loan is whatever you and the lender agree to. That flexibility is its strength and its weakness: no underwriting, no fee and a low rate, but also no standard contract, and the terms are only as firm as the paper you sign.

The rate the IRS watches

Each month the IRS publishes applicable federal rates (AFRs) in a revenue ruling. They are the yardstick for whether a private loan carries enough interest. For November 2026, Revenue Ruling 2026-21 gives a short-term AFR of 4.67% for loans of three years or less, a mid-term AFR of 5.08% for loans over three and up to nine years, and a long-term AFR of 5.52% beyond that, all with annual compounding. The short-term rate was 4.25% in October 2026, under Revenue Ruling 2026-19.

AFRs follow Treasury yields by law. Under IRC §1274(d), the short-term rate is based on the average market yield of outstanding U.S. Treasury debt with three years or less to maturity, and the other two use the same method for longer maturities. The rates for each month are set from yields during the month before, which is why the short-term AFR moved from 4.25% to 4.67% between October and November. See Treasury yields and loan rates for how those yields feed into lending.

Below-market loans and the $10,000 rule

A loan charged less than the AFR is a below-market loan under IRC §7872. When the forgone interest is in the nature of a gift, the law treats the forgone interest as if the lender gave it to the borrower and the borrower paid it back as interest, which the lender then reports as income. The IRS also says plainly that an interest-free or reduced-interest loan may be a gift.

• Up to $10,000: §7872 does not apply on any day the total outstanding gift loans between two individuals are $10,000 or less, unless the loan is directly attributable to buying or carrying income-producing assets, such as investments.
• Up to $100,000: the interest the lender is treated as receiving is capped at the borrower's net investment income for the year, and counts as zero if that income is $1,000 or less.
• Above $100,000: the cap no longer applies, and the full forgone interest at the AFR counts.

So a $5,000 loan to pay a bill can be interest-free without triggering §7872. A $30,000 loan at 0% falls under it, though below $100,000 the imputed interest is capped at the borrower's net investment income. For anything near those lines, talk to a tax professional before the money moves.

A worked example: $5,000 from a relative

Say a relative lends you $5,000, repaid monthly over 24 months. Compare three versions: interest-free, the short-term AFR, and a 24-month personal loan at 11.90% with no fee. A loan with monthly payments uses the monthly-compounding AFR from the same table, 4.58%, which equals 4.67% compounded once a year.

At the AFR you pay about $400 less than at the bank average, and about $17 less a month. Interest-free saves another $242. Your relative's interest counts as taxable interest income, so charging the AFR costs them a little tax and earns them roughly what a short-term Treasury would. Compare your own rates in the rate change calculator.

Put it in writing, and plan for a missed payment

A short signed note protects both sides. It should state the amount, the rate, the payment schedule with dates, what happens if a payment is late, and whether the borrower can repay early. A schedule from an amortization calculator, attached to the note, makes the payments concrete.

If payments stop, two things happen. The first is personal: the lender becomes a creditor at every family gathering, and the borrower carries the debt and the awkwardness. The second is tax. If the debt becomes totally worthless, the IRS lets the lender deduct it as a nonbusiness bad debt, a short-term capital loss, but only if the lender can show a loan, not a gift, was intended at the start. If they lent knowing you might not repay, the IRS treats it as a gift and allows no deduction. If the lender later forgives the balance, that can be a gift. The 2026 annual exclusion is $19,000 per recipient, and the giver, not the borrower, generally owes any gift tax.

When each one wins

The family loan is often the better tool when:

• The amount is modest, under the $10,000 line, and your relative can afford to wait if something goes wrong.
• Your credit would get a high APR, so the gap to the AFR is large.
• Both sides want it in writing and treat it like a real loan.

The personal loan wins when:

• The lender would be hurt by a missed payment, such as a parent living on fixed income.
• You want to build credit history, which a private family loan does not do.
• The relationship is already strained, or other relatives would see the loan as unfair.
• The amount is large enough to bring in §7872 or gift tax filings. If you have your own savings, compare using savings, and avoid treating a 401(k) loan as the fallback without reading its rules.

How to decide in four steps

1. 1 Price a personal loan first with lenders that prequalify with a soft check, so you know what the family loan saves.
2. 2 Agree on a rate: 0% under $10,000 if your relative prefers, or the AFR from the latest monthly revenue ruling.
3. 3 Sign a note with a schedule and set up automatic payments.
4. 4 Agree in advance what happens if you miss a payment: a grace period, a new schedule, or forgiveness as a gift.

Reader questions