Using Intrafamily Loans / how an intrafamily mortgage loan can work.

Emily Boothroyd for the Wall St. Journal writes: A lot of wealthy clients have trouble figuring out the best way to support their children financially, while still teaching them .

Often the first big lesson in financial responsibility for a client's child is buying a first home. This a great moment for parents to step in and assist children, but it's also an opportunity to pass along some of their financial wisdom.

One way to do that is through an intrafamily mortgage loan. These loans tend to have much lower interest rates then the equivalent market rates--around 3% for loans amortized at least nine years or longer, which gives children enough time to pay back the loan without generating a lot of unnecessary interest costs.

Here's an example of how an intrafamily mortgage loan can work.

The daughter of one of my wealthy clients wanted to buy a $1 million home for her and her boyfriend. The father didn't want to expose his daughter to the market rate for mortgages, but he also didn't want to just gift the money outright--even though he had the means to do so.

So I suggested he lend his daughter the money through an intrafamily loan instead. We amortized the loan for 30 years at 3%, which amounted to only about $3,000 a month in interest payments. She opted for a balloon payment structure, which means she pays only interest at first; making flexible principal payments as she chooses overtime until the 30 year term is over.

The financial risk and burden to the daughter was much less than if she'd gone to a bank, but she still had the responsibility of paying for her home. In this case the loan was a safe bet because the daughter was earning $125,000 a year on her own, and she had access to a $1.5 million trust fund, which provides her with $5,000 every month. If she chooses to pay the assets off all at once down the road, she'll have that option.

There are downsides to making this type of loan. When you make a loan to a family member to buy property, you do not have a mortgage. In other words, you don't have the ability to foreclose on the property like a mortgage lender could. You have a promissory note that you can sue to enforce, but you don't have a secured interest in the property itself--although you can create one with the assistance of an attorney.

Thinking of forgiving the interest payments from your children each year as part of your annual exclusion gifting? Think again. This will cause the entire loan to become a gift in the eyes of the IRS and you could end up unintentionally eating away at your lifetime gift exemption.

While you don't have to be extremely wealthy to make a loan to your children, I always adhere to the oxygen mask example with my clients: Provide for your safety and well-being first, and then attend to theirs. Consult with your planner to confirm that the low interest rate loan won't adversely impact your cash flow.