Applicable Federal Rate (AFR): What It Is and How To Use It

What Is the Applicable Federal Rate (AFR)?

According to the Internal Revenue Service (IRS), private loans must charge a minimum interest rate known as the applicable federal rate (AFR), published monthly by the IRS. Since private loans can vary by term length, the IRA publishes several AFRs by loan type.

How the Applicable Federal Rate (AFR) Is Determined by the IRS

The Internal Revenue Service (IRS) uses the applicable federal rate (AFR) to help people initiating personal loans determine whether they're charging enough interest. If not, both the lender and borrower could be liable for additional taxes and penalties.

Typically, a lender, such as a bank or credit union, would issue a loan at an interest rate high enough to cover the cost of processing the loan and earn a profit. The loan rate also includes the embedded risk of lending to the borrower.

However, when family members lend to one another, they might issue a loan at a below-market rate in an effort to help their family members. However, the IRS mandates a minimum interest rate that must be applied to a private loan—the applicable federal rate (AFR).

People interested in taking out a personal loan should review the AFR to see if they're charging or paying enough interest. For example, if you're making a personal loan to a family member, check that you're charging at least the AFR, or you'll get hit with a tax bill for the interest the IRS believes you should have received for the loan.

To determine the monthly AFR, the IRS considers a number of economic factors, like U.S. Treasury obligations from the previous month. It publishes these rates under Section 1274(d) of the Internal Revenue Code.

Types of Applicable Federal Rates (AFRs)

When you pull up the monthly applicable federal rate (AFR), you'll see several rates listed based on loan type. In other words, you apply a different rate depending on the length of the loan.

• Short-term AFR: Loans with a term of three years or less
• Mid-term AFR: Loans with a term of four to nine years
• Long-term AFR: Loans with a term of over nine years

The U.S. Treasury Department determines the AFRs for each term based on the average yields for marketable debt securities with similar maturities.

How to Use the AFR When Loaning Money

The easiest way to understand AFR is by providing an example of when most people will encounter the term.

Below Market Rate

Imagine you loaned money to a family member but didn't charge them interest. If the IRS learns you didn't charge interest, the IRS would tax the interest you earned, but the amount of interest would count toward your tax-free gift limit for the year.

To avoid surprises when you file your taxes, use the AFR index published the month you provided your family member the loan. To find which rate to use, you'd consider the length of the loan: short-term (three years or less), mid-term (four to nine years), and long-term (more than nine years).

Loan at the Applicable Federal Rate (AFR)

Let's say that you're loaning your sister $10,000 to be repaid within one year. Since the loan term is three years or less, you would use the annual short-term AFR. As a result, your sister would pay you 4.16% based on the AFR as of April 2025. In other words, your sister would pay you $416 in interest by the end of the year.

If you charge your sister a rate less than 4.16% (the published AFR for your loan terms), you trigger a taxable event, meaning the $416 you earned would be considered taxable income. The IRS might also impose penalties.

The Bottom Line

Paying attention to and charging the applicable federal rate might seem like just one extra step to complicate what should be a simple loan between a few people. However, the IRS uses the AFR to determine whether the interest charged is a gift or part of a loan. As a result, it's important to reference the AFR so you know how much interest to charge for a personal loan, or you'll be on the hook for additional taxes and penalties.