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Personal Loan Agreement: How to Create This Borrowing Contract
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A personal loan agreement is a written contract between two parties — generally a borrower and a lender. It outlines how much money is being borrowed and the conditions associated with paying the loan back.
Also referred to as a personal loan contract or master promissory note, this document helps to protect the parties if there’s a disagreement or dispute.
Borrowers can expect to sign such an agreement when getting funding from a financial institution, but they may also want to consider drafting a personal loan contract when lending money to friends or family.
Here’s what you should know about personal loan agreements:
What is a personal loan agreement?
As a legally binding contract, a personal loan agreement can be drawn up with an official lender – like a bank or credit union – or in a more informal situation such as with a friend who’s lending you money. Basically, it states (among other things):
- How much you’re borrowing
- When you promise to pay it back
- Any fees and/or penalties you’ve agreed to pay, depending on the scenario (such as if you prepay the debt or become delinquent)
If you default on the loan, a lender may take action in court to get its money back via wage garnishment or another method.
Most personal loans are unsecured loans, meaning you promise to pay back the funds based on your creditworthiness as a borrower. If you draft a secured personal loan contract, you must put up collateral, such as your car or your home, to back up the loan. If you don’t pay back the loan, you could lose your collateral to the lender. Make sure to review that section in your agreement.
When lending money to family or close friends, it’s a good idea to draft an official agreement to avoid any misunderstanding that could affect your relationship. While it might seem like overkill for small amounts that can be paid off by the next paycheck, you might want to consider doing the paperwork for larger personal loans that will take longer to repay.
What should be in a personal loan contract?
A personal loan agreement should include the following information:
- Names and addresses of the lender and the borrower
- Information about the loan cosigner, if applicable
- Amount borrowed
- Date the loan was provided
- Expected repayment date
- Interest rate, if applicable
- Annual percentage rate (APR), if applicable
- Payment terms, including whether the loan will be paid on demand, in installments or a as a lump sum, and the amounts and dates of payments
- Method of payment, such as through a check or cash
- Payment authorizations if required, such as for automatic withdrawals from a checking account
- Information on how potential disputes will be mediated and/or settled
- Consequences and penalties for late payments or nonpayment
- Options to change the terms of the loan
- Penalties for paying back the loan early (also known as prepayment penalties), if applicable
- Signatures from both the lender and borrower, along with the date of signing
How do you write a personal loan agreement?
While financial institutions have templates on which they base their personal loan contracts, you’ll have to draw up your own if you’re borrowing from another individual.
Depending on how complicated your personal circumstances are, you may feel you need to hire a lawyer to guide you through the process. However, the do-it-yourself approach is perfectly acceptable and just as legally enforceable. Once you have both agreed on the terms, you may want to have the personal loan contract notarized or ask a third party to act as a witness during the signing.
It’s a good idea to get together to not only hammer out the basics but also agree on a contingency plan in a worst-case scenario. This can include answers to questions such as:
- What happens if the borrower can’t keep up with payments?
- What fees and penalties would be acceptable to both of you?
- What occurs if the borrower becomes disabled or dies?
Where can you find a personal loan agreement template?
There’s no shortage of free or inexpensive templates online to help you draft a personal loan agreement. While not all personal loan agreement templates may be applicable to your situation, they could guide you and ensure you haven’t forgotten important points. Here are a couple of sites to consider:
FAQ: Personal loan agreements
What kind of lenders require personal loan agreements?
Financial institutions offering personal loans will most likely require you to sign a personal loan agreement. These can include:
However, an informal lender like a friend or family member may also, at their discretion, require you to draft and sign an agreement.
Is a personal loan contract legally binding?
A personal loan contract is a legally binding document regardless of whether the lender is a financial institution or another person. The consequences are the same if you default on the contract. As a borrower, you could be sued by the lender or lose the asset or assets used to secure the loan.
Can the terms of a personal loan agreement be adjusted after it’s signed by both parties?
Some lenders may be open to restructuring terms if you can prove economic hardship. However, that is up to the discretion of the lender.
Would the process be the same for drafting a friendly loan agreement format?
Friends and family may be more flexible than traditional lenders. But it’s important that any changes are documented (more on this soon), agreed to in writing by both parties and attached to the original agreement.
Are there family loan agreement templates available online?
There are family loan agreement templates available online. You can find some examples at these sites:
What needs to be included in a personal loan contract with collateral involved?
A loan agreement that involves collateral should include a clause on what could happen to the asset if the borrower defaults on the loan. It should clearly outline the circumstances under which the collateral could be forfeited to the lender.
Should you document a personal loan agreement?
For a personal loan agreement to be enforceable, it must be documented in writing and signed by both parties. You may choose to keep a copy in your county recorder’s office if you wish, though it’s not legally necessary. It’s sufficient for both parties to store their own copy, ideally in a safe place.