What to Include on a Personal Loan Agreement

So, you’ve decided to give financial help to a friend, family member or coworker. This is a delicate situation even with small amounts of money because default can adversely affect your personal relationship; having a loan agreement which is clear and comprehensive increases your odds of keeping the financial partnership healthy.

If the loan ends up in court the judge will look unfavorably upon obfuscating language in the loan document. The burden of proof is on you to prove that the money was not a gift and that the borrower knows to repay it. Make sure both you and the borrower understand what’s being written. The following are some important inclusions for your personal loan document.

The basics: How much is being borrowed and on what date? Your loan agreement should answer questions about how much you stand to gain. Some people have difficulty understanding interest rates and how they actually impact the balance of a loan. You gain nothing if you make a personal loan the other person is unable to pay back. How are you calculating the accrued interest? A loan where interest compounds weekly is a lot different than a loan where it compounds every day! Include a statement that the borrower agrees to keep you informed about a change of contact information.

Repayment dates: List the dates of repayment so that you’re on the same page about how much is due and when. Can he or she pay the loan early without penalty? You should try to avoid penalizing your client for paying back the balance early. If he or she reduces the principal with these payments it’s only ethical to calculate interest on the remaining balance.

Terms of default: First and foremost you need to define what constitutes a default. Is it missing a single payment or will you give them the leeway to miss a few? I recommend that you allow the borrower some time to catch up in payments before taking legal action. This shows the collection attorney that you’re not trying to entrap anyone. You don’t want the other party to incur attorney fees if he or she still intends to repay you.

Consequences of default: Definitely make it clear that collections costs will be the borrower’s responsibility. The common term used is, “the borrower agrees to be liable for reasonable legal fees”. This is fairly comprehensive and can be used to get remuneration for a warrant of debt, as well as attorney costs. This clause provides an incentive for the debtor to make payments in a timely manner. If you think you might resell the loan in case of a default be sure and include notice that it could be sold to a third party. Keep in mind that the police will not get involved in tracking down anyone who violates a contract with you. These are civil matter and not criminal ones.

Amnesty provisions: If the borrower loses his or her job or is unable to make payments then you might want to work with them to restructure the loan. Include a provision that shows you’re willing to restructure ahead of time. What you don’t need is someone refusing to return your calls because they’re ashamed to confront you.

Signature of a notary: Without getting the document notarized the borrower can contest that it is his or her signature on the document. Take the precaution of going to the bank and having the notary public sign your document. Warning: This does not make the document legal or binding but is just a written record that you two were the signatories.