A personal loan agreement is a legally binding contract between a lender and borrower that spells out the terms of a loan transaction. Unlike formal bank loans or financial institution, personal loans often involve lending money to friends or family members. Because of the informal nature of these loans, having a written loan agreement is extremely important. A personal loan agreement documents key details about the loan (amount of money) and serves as evidence of the monetary transaction.
In this blog post, we will take a look at the key components to include in a personal loan agreement template. We will also review tips on structuring loan terms between family and friends. Read on to learn more about creating an enforceable personal loan contract to protect both the lender and borrower.
Types of Personal Loans Covered in the Agreement
A personal loan agreement can cover informal loan arrangements between:
- Family members – Parents may lend money to a child for a major purchase like a home or car. Siblings or grandparents may also lend money to help with big expenses.
- Close friends – You may feel comfortable lending money to a life-long friend in financial need. Friends entering a business venture together may also use a loan agreement.
- Loans from retirement accounts – You can take a loan from your 401k or other retirement savings by proving the funds will be used for specific purposes like medical bills. The loan must be paid back as outlined in the loan agreement to avoid tax penalties.
- Hard money loans – These loans are given based on the value of an asset used as collateral like real estate or equipment. The lender receives the deed or title to the asset if the borrower defaults.
Key Sections to Include in a Loan Agreement
A basic personal loan agreement template should contain the following components:
- Loan amount – The exact dollar amount being borrowed.
- Loan purpose – The reason the borrower needs the funds.
- Interest rate – The percentage charge added to the loan amount that the borrower pays.
- Payment schedule – Specific monthly due dates and amounts for repayment installments.
- Late fees – Charges added if payment is after the due date.
- Collateral – Asset used to secure the loan in case of default.
- Repayment terms – The timeline for repaying the full loan amount.
- Default clauses – Conditions that allow the lender to take legal action for nonpayment.
- Acceleration clause – Allows lender to demand full repayment if certain conditions are triggered.
- Governing law – The state laws that regulate the loan terms.
How to Structure the Loan Application Process
Before finalizing a personal loan agreement, the lender will want to assess the borrower’s ability to repay the loan. Most personal loan applications require:
- A credit report to review the applicant’s credit card history or credit history and proof of address
- Proof of income from recent pay stubs or tax returns
- Bank statements to verify consistent cash flows
For very large loans, the lender may also want:
- Tax returns for 2-3 years to prove stable income
- Documentation on expenses and other debts
- Collateral to secure the loan like a car title or property
It is also a good idea to provide debt-to-income ratio to prevent unsecured loans. For a very lager loan, the borrowers may ask for lower interest rates while a smaller loan may require a higher interest rate.
The lender analyzes the borrower’s creditworthiness and risk level based on this information. Higher risk borrowers may need a cosigner with better credit or higher interest rates. Financial institutions like banks and credit unions will follow a similar loan application process.
Structuring the Monthly Repayment Terms
The payment schedule is a very important component of the loan agreement. The lender wants to ensure regular monthly payments, while the borrower wants affordable installments. A few tips on structuring repayments:
- Set specific payment amounts and due dates – For example, $200 due on the 1st of every month.
- Tie payments to the borrower’s pay schedule – If the borrower is paid biweekly, the payments can coincide with pay days.
- Require automatic payments from the borrower’s bank account – This prevents missed payments.
- Allow for early repayment – Don’t penalize early payoff of the full principal amount.
- Charge late fees equal to a small percentage of the late payment amount – For example, 5% of the missed payment.
- Accelerate the loan upon default – The lender can demand full repayment of the outstanding balance.
The Importance of a Promissory Note
In addition to a personal loan agreement, the parties should sign a promissory note. This is a legal document that gives more details about the loan obligations:
- The full names and addresses of the lender and borrower
- The loan amount, interest charged, and repayment schedule
- Collateral or security put up for the loan
- The specific events that would trigger default
- Signatures from both parties
A promissory note strengthens the lender’s legal position if the borrower defaults or tries to challenge the terms of the loan. It provides documentation that can be used in court if legal enforcement becomes necessary.
Tips for Ensuring the Agreement is Legally Enforceable
Because personal loans involve family and friends, some key steps should be taken to make the agreement enforceable:
- Review your state’s lending laws – Certain types of loans are regulated and interest rate caps may apply.
- Consult an attorney to ensure the agreement is valid – Legal advice can help prevent any clauses that could invalidate the contract.
- Require notarized signatures from both parties – This verifies the identity and willing participation of the borrower.
- File the agreement with the town clerk or county recorder – This makes the agreement part of public record.
- Include witness signatures – Having a neutral third party sign prevents claims of coercion.
Where to Find a Free Personal Loan Agreement Template
Many websites offer free personal loan agreement templates that you can download and customize:
- Rocket Lawyer – Options for promissory notes and loan contracts for different types of lenders.
- PDF format – Allows you to add details specific to your loan situation.
- HelloSign – Offers templates designed by attorneys that can be e-signed.
- LawDepot – Questionnaire style tool that creates tailored agreements.
- WikiForms – Wide selection of loan contract templates.
Be sure to choose a reputable source for contract templates. It’s worth paying a small fee for templates reviewed by legal experts.
Unsecured Personal Loans
If the borrower does not have collateral, an unsecured personal loan may be an option. This is a common loan type from banks and credit unions. The lender provides funds based on the borrower’s creditworthiness alone. The loan agreement still clearly defines the repayment terms. But there is no asset for the lender to seize if the borrower defaults.
Entering into a carefully structured personal loan agreement benefits both the lender and borrower. With life’s unexpected financial needs, family and friends can be a great resource. But protecting relationships in the long-run means documenting the loan details clearly.
The agreement should outline fair monthly repayment terms tailored to the borrower’s budget. Lenders should still assess if the borrower can manage the required payments. Having an enforceable contract prevents misunderstandings down the road.
We hope this overview on personal loan agreements offers useful tips for both lenders and borrowers. Be sure to consult a financial advisor or attorney to ensure your agreement abides by state laws and regulations. With some diligence on the front-end, lending money to family and friends can be a mutually beneficial arrangement for all parties involved.
Personal Loans Document Examples
Here is a sample personal loan agreement document:
Personal Loan Agreement
This loan agreement (“Agreement”) is made this [date], between [Borrower’s name] (“Borrower”) and [Lender’s name] (“Lender”).
- Loan Amount. Lender agrees to lend Borrower the sum of [loan amount] (the “Loan”) to be used by Borrower for personal expenses.
- Interest. No interest will be charged on the Loan.
- Repayment. Borrower promises to repay the Loan in [number] payments of [dollar amount] each, payable on the [day] day of each month, beginning on [date]. Any remaining balance shall be due and payable on [maturity date].
- Late Payments. If any payment is more than 10 days late, Borrower agrees to pay a late fee of [late fee amount or percentage].
- Acceleration. If Borrower defaults in the payment of this Loan or in the performance of any obligation in the Agreement, the entire balance will become immediately due and payable at the election of Lender.
- Collections. Borrower agrees to pay all costs incurred by Lender in collecting sums due under this Agreement, including reasonable attorneys’ fees.
- Modification. No modification of this Agreement will be enforceable unless in writing and signed by both parties.
- Governing Law. This Agreement is governed by the laws of the State of [governing law state].
- Signatures. This Agreement is executed this [date] by:
Borrower [Printed Name]
Lender [Printed Name]
I certify that I have read and agree to the terms of this Loan Agreement.