Why a written agreement matters
Most private loans start with a handshake or a text message. That works fine until it doesn't — a payment is missed, memories differ on the terms, or someone needs to prove the loan existed for tax purposes.
A written loan agreement fixes all of this. It's not about distrust. It's about making sure both sides have the same understanding of what was agreed to, documented in a way that holds up if anything goes wrong.
You can't enforce the loan in court. You can't prove the terms to the IRS. You can't claim a bad debt deduction if the borrower stops paying. And you can't resolve a “he said / she said” dispute about what was actually promised.
A written agreement also changes the borrower's behavior. When someone signs a document committing to specific payment dates and amounts, they treat the obligation differently than a verbal promise made over dinner.
Who needs a private loan agreement
If money is changing hands and the expectation is repayment, you need a written agreement. The relationship between lender and borrower doesn't matter — the document does.
The most common scenario. Personal relationships make it harder to discuss terms openly, which is exactly why writing them down matters more.
Loans between business partners or to a partner's business need clear separation between personal and business obligations.
Professional private lenders use agreements as standard practice. The terms are typically more detailed, including collateral, lien positions, and cure periods.
Salary advances, relocation loans, or training cost agreements all benefit from documented terms to avoid disputes during or after employment.
The IRS treats all of these the same: if it's a loan, it needs documentation. If it's undocumented, the IRS may reclassify it as a gift — with potential tax consequences for the lender.
Essential terms every agreement needs
Your agreement doesn't need to be 20 pages. It needs to be clear. Every private loan agreement should include these core terms at minimum:
- Full legal names and contact information for both parties
- Principal amount (the exact sum being lent)
- Interest rate and how it's calculated (fixed, variable, or 0%)
- Repayment schedule — payment amounts, due dates, and frequency
- Late payment terms (grace period, fees, default triggers)
- Collateral description, if the loan is secured
- Signatures and date from both lender and borrower
Each of these terms eliminates a category of dispute. The principal prevents “I thought it was less.” The schedule prevents “I thought I had more time.” The signatures prevent “I never agreed to that.”
The following sections break down each of these in detail, so you know exactly what to write and why.
How to set the interest rate
Your agreement must state the interest rate explicitly — even if it's 0%. Leaving it blank creates ambiguity and potential tax problems.
The IRS minimum: Applicable Federal Rate
For loans over $10,000, the IRS requires the lender to charge at least the Applicable Federal Rate (AFR). If you charge less, the IRS may treat the difference as a taxable gift from lender to borrower.
What to write in the agreement
State the annual percentage rate, whether it's fixed or variable, and how interest is calculated. For amortized loans, specify that each payment covers both interest and principal. For interest-only loans, specify when the principal balance is due.
Example language: “The Borrower shall pay interest at a fixed annual rate of 5.0%, calculated on the outstanding principal balance, with interest and principal amortized over 24 monthly installments.”
Usury limits
Most states cap the interest rate you can charge on private loans. Exceeding the usury limit can void the interest provision — or in some states, the entire agreement. Check your state's usury laws before setting a rate. For most personal loans, staying at or near the AFR keeps you well within legal limits.
Repayment terms and schedules
The repayment section is where most private loan agreements either succeed or fail. Vague terms like “pay me back when you can” aren't enforceable and create friction. Your agreement needs specific, measurable commitments.
What to include
- Payment amount — the exact dollar amount due each period
- Payment frequency — monthly, biweekly, or weekly
- First and last payment dates — when payments begin and when the loan matures
- Payment method — bank transfer, check, or platform
Amortization vs. balloon payments
Each payment covers interest and a portion of principal. The balance decreases with every payment. This is the most common and predictable structure for both sides.
The borrower makes smaller periodic payments (often interest-only) with the remaining principal due in a lump sum at the end. Higher risk for the lender — the borrower may not have the lump sum when it's due.
Prepayment and early payoff
State whether the borrower can pay off the loan early without penalty. Most private loans allow prepayment, but it should be explicit. If the borrower makes an extra principal payment, specify whether it reduces the remaining term or the monthly payment amount.
Default and late payment clauses
No one wants to think about default when writing a loan agreement. But this section is what protects the lender if things go sideways — and what motivates the borrower to stay current.
Grace period
Define how many days after the due date a payment is considered late. A 5-day grace period is standard for private loans. This accounts for weekends, bank processing delays, and real life without being overly lenient.
Late fees
If you charge late fees, state the amount or percentage clearly. Example: “A late fee of 5% of the payment amount will be assessed for any payment received more than 5 days after the due date.” Check your state's regulations — some states cap late fees on private loans.
Events of default
Your agreement should define exactly what constitutes default. Common triggers:
- Failure to make a payment within 30 days of the due date
- Borrower becomes insolvent or files for bankruptcy
- Borrower provides false information in the agreement
- Collateral is damaged, sold, or encumbered without consent
Acceleration clause
An acceleration clause allows the lender to demand the entire remaining balance immediately upon default. Without this clause, you'd have to sue for each missed payment individually. This is one of the most important provisions in any loan agreement.
Collateral and security interests
A secured loan includes collateral — an asset the lender can claim if the borrower defaults. This significantly reduces lender risk and often allows for better terms for the borrower.
What to include in the collateral section
Be specific. For vehicles: year, make, model, and VIN. For real estate: full property address and legal description. For equipment: serial numbers and condition.
State whether this is a first, second, or subordinate lien. The lien position determines who gets paid first if the borrower defaults and the collateral is sold.
The borrower should agree to maintain, insure, and not sell the collateral without the lender's written consent. Any transfer or damage should trigger a default provision.
Define what happens to the collateral upon default. How many days notice does the borrower get? Does the lender take possession directly, or does it go through a legal process?
UCC filings
For personal property (vehicles, equipment, inventory), lenders can file a UCC-1 financing statement with the state to publicly record their security interest. This prevents the borrower from using the same collateral to secure another loan without the first lender's knowledge. For real estate, the equivalent is recording a deed of trust or mortgage with the county.
Legal enforceability
A private loan agreement is a legally binding contract. But certain provisions strengthen its enforceability and protect both parties if the agreement ever ends up in front of a judge.
Governing law
Specify which state's laws govern the agreement. This matters if the lender and borrower live in different states. It also determines which usury limits, collection rules, and court procedures apply.
Dispute resolution
You can require mediation or arbitration before either party files a lawsuit. This is often faster and cheaper than court, and keeps the dispute private. Alternatively, you can specify which court has jurisdiction.
Signatures and witnesses
Both parties must sign and date the agreement. While most states don't require notarization for a private loan agreement, having the signatures notarized adds a layer of authentication that makes the document harder to challenge in court.
Some people use dedicated loan management platforms to generate and store these agreements digitally, which creates a timestamped audit trail that serves as additional evidence of the agreement's authenticity.
Severability: If one clause is found invalid, the rest of the agreement still holds. Entire agreement: States that the written document is the complete agreement, superseding any verbal promises. Amendment process: Requires any changes to be made in writing and signed by both parties.
Frequently asked questions
Is a private loan agreement legally binding?
Yes. A private loan agreement is a legally binding contract as long as it includes an offer, acceptance, and consideration (the loan itself). Written agreements are far easier to enforce than verbal ones. Most states allow private loan agreements without notarization, though notarizing adds an extra layer of authenticity.
Do I need a lawyer to write a private loan agreement?
Not for most personal loans. A clear, written agreement covering principal, interest rate, repayment schedule, and default terms is usually sufficient. For large loans (over $50,000), loans involving real estate collateral, or complex terms, consulting an attorney is a reasonable precaution.
What's the difference between a loan agreement and a promissory note?
A promissory note is a one-sided promise from the borrower to repay. A loan agreement is a two-sided contract that both parties sign, covering detailed terms like default clauses, collateral, and dispute resolution. Loan agreements offer stronger legal protection for the lender because they bind both parties to specific obligations.
What interest rate should I charge on a private loan?
For loans over $10,000, the IRS requires at least the Applicable Federal Rate (AFR) to avoid the forgone interest being treated as a taxable gift. The AFR varies by loan term (short-, mid-, and long-term) and is published monthly. You can charge 0% on loans under $10,000 without tax consequences, but documenting the rate in writing is still recommended.
Can I add collateral to a private loan agreement?
Yes. Including collateral (a vehicle, property, equipment, or other asset) in your agreement gives the lender recourse if the borrower defaults. The agreement should describe the collateral specifically — make, model, VIN for vehicles, or property address for real estate — and state that the lender has a security interest in it.
What happens if someone breaks a private loan agreement?
If the borrower defaults, the lender can pursue the debt through small claims court (for smaller amounts) or civil court. A written agreement with clear terms makes enforcement straightforward. Without a written agreement, proving the loan existed — and its terms — becomes much harder. Most judges will side with whatever the documentation says.