Lending Your Grandchild Money for College: The FAFSA Rules & Family Loan Guide

College tuition is at an all-time high, and student loan interest rates on federal and private loans can be intimidating for young students.

As a grandparent, you may want to step in and help. You have the savings, and you want to give your grandchild a head start in life by keeping them out of high-interest student debt.

But college funding is wrapped in a web of government rules—specifically the FAFSA (Free Application for Federal Student Aid) and IRS gift taxes.

If you want to help your grandchild pay for school, here is what you need to know about the latest FAFSA rules, and how to structure a low-interest grandparent-to-grandchild student loan that teaches responsibility without hurting their financial aid.

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1. The Big FAFSA Change: Grandparent Help is Safer Than Ever

For years, grandparents had to be extremely careful when paying for college.

Under the old FAFSA rules, if a grandparent paid tuition directly or gave cash to a student, that money was classified as "untaxed student income" on the following year's FAFSA. Because the formula expects students to contribute 50% of their income to college costs, a $10,000 gift from a grandparent could reduce the grandchild’s financial aid by up to $5,000 the next year.

Thankfully, the rules have changed.

Under the updated FAFSA formula, student aid calculations are pulled directly from federal tax returns (Adjusted Gross Income). Because cash gifts and direct tuition payments from grandparents do not appear on a student's tax return, grandparent financial help no longer penalizes the student’s financial aid eligibility.

You can now pay tuition directly to the school or assist your grandchild without worrying about a FAFSA penalty.

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2. Why Choose a Family Loan Over a Cash Gift?

If financial aid is no longer an obstacle, why structure your help as a loan instead of a direct gift?

Many grandparents choose a family loan for two key reasons:

1. Teaching Accountability: College is the transition into adulthood. Gifting a grandchild a free education can sometimes lead to a lack of academic focus. A low-interest loan establishes that they have a personal stake in their education.
2. Preserving Your Retirement: You want to help, but you also need to ensure you don't deplete your own retirement nest egg. A loan allows you to fund their education now, with the security of knowing that capital will return to you in the future.

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3. How to Structure a Grandparent Student Loan

To set up a family student loan that is fair, educational, and tax-compliant, follow these steps:

Set a Grandparent-Friendly Interest Rate

You don't need to charge the high rates of federal or private student loans (which can range from 6% to 15%). However, for loans above $10,000, the IRS requires you to charge an interest rate at or above the Applicable Federal Rate (AFR). Charging a low rate (like 3%) keeps the loan tax-compliant while saving your grandchild thousands of dollars compared to traditional lenders.

Defer Payments Until After Graduation

In traditional student loans, payments are deferred while the student is in school. You can write this exact clause into your family agreement: "Repayment will begin six months after graduation or when the borrower ceases to be enrolled at least half-time." Interest can accrue during school, or you can choose to make it interest-free until graduation.

Define a Reasonable Term

Give them time to build a career. A standard 120-month (10-year) repayment term is common for student loans. This keeps their monthly payments small and manageable once they enter the workforce.

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4. Keep the Record Professional

Lending money to a grandchild can feel personal, but the record-keeping should be professional. If you track the payments on scrap paper or try to remember who paid what over a 10-year repayment schedule, misunderstandings are inevitable.

BankOfGaga keeps a clean, shared record of the loan schedule, handles the interest calculations, and sends friendly reminders to your grandchild when payments begin—keeping the family relationship warm and centered on support rather than debt collection. Try it free for 30 days →