My wife's grandfather has offered to loan me money for law school at 4% interest. This interest rate is obviously less than the standard government loan rate of 7%, however, my first question is: am I able to deduct the interest of the loan from my grandfather (because its an educational loan) like I would be able to from the government loan? If I am not able to deduct the interest then does the interest from my grandfather's loan make it more expensive even though its at a lower interest rate? Which do loan do you think is the better option?

More questions:

1. Is grandpa's loan eligible for IBR?
2. Is grandpa's loan eligible for public interest forgiveness?
3. Does grandpa know you might default?

Don't know whether you'd be able to deduct the interest from the grandfather loan. That said, the answer to that question doesn't matter, because the deduction for student loan interest is fucking pathetic. It has a cap of $2,500, and phases out completely far below biglaw-level income. You get some benefit from the deduction for your stub year, but that's about it. (The fact that you're considering a loan from a family member makes me assume you're going to a school where biglaw is a high-percentage outcome; if you are not, you shouldn't take his money, because you do not want to have to deal with deferring *family* loan payments--assuming he would let you defer, if you needed to.) You should also keep in mind that the loan from your grandfather won't be eligible for PSLF, if you go that route.

We have agreed that my minimum payments after graduation will be 10% of my gross monthly income. Its not eligible for public interest forgiveness. Yes, he is aware that he is taking on the risk of default but is willing to help me with my education regardless (hopefully it won't come to that lol).

I mean, I would never accept this kind of loan, because the idea of defaulting on a loan from a family member makes me violently ill. If that intangible doesn't bother you, though, the math obviously works out in favor of the loan from your grandfather.

Thanks for the advice. It does make me nervous so I've got some thinking to do

Gramps might tell you it is a loan for now, but not asked to be repaid when you start offering to pay.

Kind of along this line, I have seen intra-familial loans more or less tearing families apart when expectations weren't met or something else went wrong. That is obviously a worst-case scenario, but I really am aware of numerous situations involving 'loans' by family members that became a major problem for various reasons. I think if your grandfather is willing to give you gift money (and make it clear there is no expectation of repayment) then that is one thing, but I would definitely take the govt loan over a family loan otherwise. That is true even it is was an interest-free 'loan.' Too easy for things to get complicated. But if he did become willing to give a gift (even if less than the amount of 'loan' he is offering) then I think if you are comfortable with it and he indicates no strings attached then I would accept it. Even a small gift could offset the extra interest of a govt loan considerably, but regardless I wouldn't do the family loan.

http://www.irs.gov/pub/irs-pdf/p970.pdf

Section 4 should be relevant.

Do not accept the loan if you defaulting (or even just being a little slow to pay it back) would negatively affect him in any way.

If he would literally not miss a dollar of the money, then consider the other factors that others have already brought up.