How Much Interest to Charge When Lending Money: AFR and Usury Limits

When you’re deciding how much interest to charge when lending money to a friend, relative, or business contact, the rate needs to sit between two hard boundaries: at the low end, the IRS Applicable Federal Rate (AFR) for the month you make the loan; at the high end, your state’s usury cap. As of early 2026, the AFR runs roughly 3.5 to 4.7 percent depending on the loan’s length. Charging less can create gift-tax exposure and force you to pay income tax on interest you never collected. Charging more than the state cap can wipe out your interest, your principal, or both. Everything else, from the borrower’s credit to what a savings account would pay you, decides where inside that range you land.

The IRS Floor: Applicable Federal Rates

The IRS publishes minimum interest rates every month called Applicable Federal Rates. Lend below the AFR (or charge no interest) and the IRS treats the shortfall two ways at once: as a gift from you to the borrower, and as “forgone interest” the borrower is deemed to have paid back to you. The second half is what stings. You owe income tax on interest that never actually reached your account.¹

The applicable rate depends on the repayment term:

Short-term (3 years or less): approximately 3.59 percent annually as of March 2026.
Mid-term (over 3 years, up to 9 years): approximately 3.93 percent.
Long-term (over 9 years): approximately 4.72 percent.

These figures change every month. You lock in the rate from the month the loan is executed, so pull the current revenue ruling from the IRS’s Applicable Federal Rates page before you sign anything.²

Small-Loan Exceptions

Not every private loan gets pulled into the imputed-interest rules. Two dollar thresholds do a lot of work for smaller loans between individuals.

Loans of $10,000 or Less

If the total outstanding balance between you and the borrower stays at or below $10,000, the below-market loan rules generally don’t apply. You can charge zero interest without triggering gift or phantom-income consequences. The exception falls away if the borrower uses the money to buy or carry income-producing assets like stocks or rental property.¹

Loans Between $10,001 and $100,000

In this range the below-market rules still apply, but the imputed interest is capped at the borrower’s net investment income for the year. If that net investment income is $1,000 or less, it’s treated as zero and nothing is imputed. The relief disappears if a principal purpose of the loan is federal tax avoidance, and it ends entirely once the aggregate balance passes $100,000.¹

Loans Over $100,000

Above $100,000, the full imputed-interest regime applies. Forgone interest is treated as a gift to the borrower and as income to you at the same time. If the forgone interest exceeds the annual gift-tax exclusion, which is $19,000 per recipient for 2026, you may also need to file a gift-tax return.³⁴

The State Usury Ceiling

Every state sets a maximum interest rate for consumer loans through its usury law. The caps vary widely. Some states cut private consumer loans off at 5 or 6 percent per year, others allow above 20 percent, and a few have no hard cap for certain loan types. Before setting your rate, check the usury limit in the state whose law will govern the loan, which is usually the borrower’s home state or the state named in the agreement.

Exceeding the cap can be expensive. Some states void the interest and leave you with only the right to collect principal. Others take it further: forfeiture of both principal and interest, or the borrower recovering two or three times the excess interest charged. Certain jurisdictions also have criminal usury statutes, where extremely high rates can bring felony charges.⁵

Business and Commercial Loans

Many states exempt loans made primarily for business, commercial, agricultural, or investment purposes from the standard consumer usury cap. Lending to a friend’s business rather than covering a personal expense may leave you free to charge more, sometimes with no cap at all. The exemption usually turns on the actual purpose of the funds, not the borrower’s status as a business owner. Confirm your state recognizes the distinction before you rely on it.

Picking a Rate Inside the Range

Once you know the floor and ceiling, the rate you actually charge comes down to a handful of practical factors.

Borrower Risk

The borrower’s ability to repay is the biggest driver. Credit score, income stability, and existing debt relative to income all matter. A borrower with a strong credit profile and steady income justifies a rate near the floor. Someone with thin income or a history of missed payments warrants more to compensate for the added risk.

What Your Money Could Earn Elsewhere

Your rate should reflect what the same dollars could return in comparable, low-effort alternatives. If a high-yield savings account pays 4.5 percent, charging 3 percent on a private loan means you’re subsidizing the borrower. Treasury bonds, certificates of deposit, and money-market funds are useful benchmarks. Matching or slightly exceeding those returns, adjusted for the borrower’s risk, keeps the arrangement fair on both sides.

Collateral

A secured loan is less risky, which usually justifies a lower rate. If the borrower pledges a vehicle, equipment, or real property, you have something to recover on default. Unsecured loans, backed only by the borrower’s promise, run higher. Commercial lenders price secured and unsecured products meaningfully apart for the same reason.

Inflation

The dollars coming back to you buy less than the dollars you sent out, especially on longer terms. If inflation runs around 3 percent and you charge 3 percent, your real return is roughly zero. Build expected inflation into the rate so the loan at least preserves the value of your money.

Simple or Compound Interest

The rate isn’t the whole story. How interest is calculated changes what the borrower ultimately pays and belongs in the written agreement.

Simple interest is calculated only on the original principal. A $10,000 loan at 5 percent simple interest generates $500 in interest each year regardless of what’s been paid. It’s predictable, easy to run in your head, and common in private lending.

Compound interest charges interest on the principal plus any accrued interest that’s been added to the balance. The balance grows faster over time because each calculation runs on a larger base. Compounding frequency, whether monthly, quarterly, or annually, decides how quickly. Annual compounding is the mildest; monthly compounding is the most expensive for the borrower.

Put It in a Promissory Note

A written promissory note turns a verbal promise into an enforceable contract. Even between family or close friends, a written record protects both sides and gives you something to point to if the arrangement sours. At a minimum, the note should cover:

Full legal names and addresses of the lender and borrower.
The exact principal amount.
The annual interest rate and whether it’s simple or compound (and if compound, how often).
The repayment schedule, whether installments or a single maturity date, with payment amounts.
The date of execution, which fixes when interest starts to accrue.
Late-fee terms, including the grace period before the fee applies.
An acceleration clause letting you demand the full remaining balance on default. Most such clauses are optional for the lender and many allow the borrower to cure the default first.
Signatures and dates from both parties.

Notarization adds authentication. If the loan is secured by real property, you may also need to record a deed of trust or mortgage with the county. Written promissory notes generally get a longer statute of limitations than oral agreements, commonly three to six years depending on the state.

Tax Reporting Once You’re Collecting Interest

Interest you receive on a private loan is taxable income, reported the same way as interest from a bank.

If a borrower pays you $10 or more in interest during the year, you have to file Form 1099-INT with the IRS and send a copy to the borrower.⁶ The borrower’s copy is due January 31 of the following year. Paper filings with the IRS are due by the end of February; electronic filings by March 31.⁷ Even when the total is under $10 and no 1099-INT is required, the interest is still taxable to you. Late or missing forms carry per-form penalties that climb the longer you wait and stack separately for the IRS copy and the borrower copy.⁸

On your own return, taxable interest, including from private loans, goes on Schedule B of Form 1040 if your total interest and ordinary dividends exceed $1,500 for the year. Interest from a seller-financed mortgage requires Schedule B regardless of amount.⁹ If the IRS has imputed interest on a below-market loan, that phantom interest is taxable too, even though no money moved.¹

1
Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates
2
Internal Revenue Service. Applicable Federal Rates
3
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
4
Office of the Law Revision Counsel. 26 USC 2501 – Imposition of Tax
5
Utah Legislature. Utah Code 76-6-520 – Criminal Usury
6
Internal Revenue Service. About Form 1099-INT, Interest Income
7
Internal Revenue Service. General Instructions for Certain Information Returns
8
Internal Revenue Service. Information Return Penalties
9
Internal Revenue Service. About Schedule B (Form 1040), Interest and Ordinary Dividends