A loan agreement serves as a crucial legal contract between a borrower and a lender, delineating the terms and conditions of a financial arrangement. Whether you're borrowing or lending within family circles, from friends, or obtaining a loan from a financial institution for a significant purpose like a home, car, or education, having a well-structured loan agreement is indispensable.

Table of Contents

• What Is a Loan Agreement?
• Types of Loan Agreements
• Who Needs a Loan Agreement?
• When To Use a Loan Agreement?
• How To Write a Loan Agreement
• Frequently Asked Questions
• Loan Agreement Sample

What Is a Loan Agreement?

At its core, a loan agreement is a written contract, legally enforceable, that solidifies the understanding between a lender and a borrower. It outlines the borrowed amount, repayment schedule, and, if applicable, the interest rate. Commonly referred to as a business loan agreement, loan contract, personal loan, promise to pay, or secured/unsecured note, it provides a legal framework that ensures both parties uphold their commitments.

What’s the Difference Between a Loan Agreement, Promissory Note, and IOU?

A loan agreement is generally more formal and less flexible than a promissory note or IOU. This agreement is typically used for more complex payment arrangements and often gives the lender and borrower more protections, such as borrower representations, warranties, and covenants.

In a loan agreement, a lender can accelerate the loan if the borrower defaults. So if the borrower misses a payment or goes bankrupt, the lender can make the entire amount of the loan plus any interest due and payable immediately.

Here is a simple chart explaining the difference between an IOU, a promissory note, and a loan agreement.

Loan	Promissory Note	IOU
promise to repay	promise to repay	promise to repay
steps for repayment	steps for repayment	-
timeline to repay	timeline to repay	-
legally binding	legally binding	-
signature of borrower	signature of borrower	-
signature of lender	-	-
repay in installments	-	-
consequences of defaulting (i.e. right to foreclosure)	-	-

How Will the Money Be Repaid?

The loan agreement should detail how the borrower will pay the money back and what happens if the borrower cannot repay.

There are generally four types of repayment options:

Installment Payments	Installments with Final Balloon Payment	Due on Specific Date ("Lump Sum")	Due on Demand (“Payable on Demand”)
Specific due date	Specific due date	Specific due date	No specific due date
Payments for principal and interest are made at regular intervals	Payments for interest only are made at regular intervals, principal amount due on maturity date	Entire amount owed, including interest, is paid all at once	Entire amount owed is due whenever the lender wants his or her money back
Example: $1,500 monthly payment actually consists of $500 towards the outstanding principal and $1,000 towards the interest with $1,500 due on the maturity date	Example: $500 monthly payment is applied only towards interest and full $10,000 loan amount is due on the maturity date	Example: $10,000 loan for a friend’s small business is due on a specific date	Example: $10,000 loan for a friend's small business is due at any time or whenever financially feasible

Types of Loan Agreements

1. Co-sign Loan:
Co-signing a loan makes you equally responsible for repayment if the primary borrower defaults. This is common in familial or close relationships.

2. Fixed-rate Loan:
Fixed-rate or term loans maintain a consistent interest rate throughout the loan term, offering stability in repayments.

3. Secured Loan:
Secured loans necessitate collateral, such as a home or vehicle, which the lender can seize if the borrower fails to repay.

4. Unsecured Loan:
Unsecured loans don't require collateral but may demand a higher credit score. Signature loans, credit cards, and student loans fall into this category.

5. Variable-rate Loan:
Variable-rate loans have fluctuating interest rates, often linked to an index like the federal funds rate.

Who Needs a Loan Agreement?

While loans can occur between family members, called a family loan agreement – this form can also be used between two organizations or entities conducting a business relationship.

Here is a table detailing common borrowers and lenders who might need this agreement:

Possible Lender	Possible Borrower
Seller of a home	Buyer of a home
Seller of a car	Buyer of a car
Investor	Startup company
Family member	Family member
uncle or aunt helping their favorite family member	nephew or niece paying for education or a wedding
older wealthier family member divesting estate (i.e. grandparents)	younger less wealthy family members in need of financial assistance (i.e. grandchildren)
Sympathetic friend with extra funds (i.e. able to lend but not give money)	Reliable friend with unexpected debt (i.e. unforeseen medical bills)

When To Use a Loan Agreement?

Utilize a written loan agreement whenever money is lent or borrowed. Relying solely on verbal agreements can lead to misunderstandings. Complex payback terms and interest calculations are best clarified in a written agreement. Instances where a loan agreement is vital include starting a business, real estate transactions, education financing, vehicle purchases, and even personal loans among friends or family.

However, when crafting loan agreements within family circles, consider potential tax implications. Lending without interest may attract taxes, and borrowed money treated as a gift might also incur taxes. Understanding the Applicable Federal Rate (AFR) is crucial in family transactions.

Beware of Predatory Lending:
Loan agreements aren't just about legalities; they also serve as safeguards against predatory lending. Exorbitant interest rates could be a red flag. Loan sharks, notorious for exploiting borrowers with high-interest rates, can lead individuals into a vicious debt cycle. If an interest rate appears unreasonably high, consider it a warning sign.

How To Write a Loan Agreement

Here’s a step-by-step on writing a simple Loan Agreement with a free Loan Agreement template.

Step 1 – Name the Parties

A Loan Agreement should detail the name of the lender and borrower. It should include their legal name, not informal designations or “nicknames.” This legally identifies the parties involved in the loan, so a proper legal designation of the parties is essential. The initial section of your agreement should look like this:

An example of where to include information about the parties involved in a loan agreement

Step 2 – Write Down the Loan Amount

Provide the amount you will be loaning the borrower. This amount is referred to as the ‘principal sum’. It does not take into account the total amount, including interest.

An example of where to include the loan amount in our loan agreement template

Step 3 – Specify Repayment Details

This section is where you must provide the details of the borrower’s loan repayment. The options you choose will have to be mutually agreed upon. You can choose whether the loan will be repaid in regular payments or at once.

Regular Payments: The borrower repays the lender in a set number of payments over a set period of time as specified in the document.

Single Payment: The borrower repays the lender all at once by the date specified by the lender OR “on-demand” by the lender. With a “Due on Demand” payment option, the borrower repays the loan upon the lender’s demand.

If you choose regular payments, you must specify the repayment schedule, which can be monthly, quarterly, semi-annual or annual installments.

An example of where to include information about repayment in our loan agreement template

Step 4 – Choose How the Loan Will Be Secured (Optional)

If you want the loan to be secured, you can include the property the borrower has put up for collateral here. Make sure you are specific, providing as many relevant details as possible. Both parties must mutually agree upon this property for it to be legally valid in court.

An example of where to include information regarding collateral in our loan agreement template

Step 5 – Provide a Guarantor (Optional)

A cosigner or guarantor is optional and protects the lender if the borrower defaults on the Loan Agreement. You may require a cosigner if the borrower is in questionable financial standing. The cosigner is someone who jointly signs the agreement with the borrower.

If the borrower defaults and cannot pay back the amount in full, the cosigner is responsible for paying you back the due amount. The cosigner is usually someone in good financial standing or has excellent credit.

An example of where to include information regarding guarantors and co-signers in our loan agreement template

Step 6 – Specify an Interest Rate

You should include the interest rate you will be charging the borrower in a percentage. This interest rate will be applied to the principal amount of the loan, and the borrower must agree to this rate.

An example of where to include the interest rate in our loan agreement template

Step 7 – Include Late Fees (Optional)

As a lender, you can charge late fees if the borrower does not meet a payment in time. Including a late fee can motivate the borrower to make payments on the agreed dates.

An example of where to include late payment fees in a loan agreement

Step 8 – Determine Options for Prepayment

You can include whether penalties or discounts will be applied if the borrower decides to pay the loan amount ahead of schedule. Alternatively, you can explicitly state that the agreement does not allow prepayment of the loan.

A penalty is usually applied to deter the borrower from paying the loan back early and to encourage long-term payments. The loan would then accrue more interest, which can be a favorable arrangement if you’re the lender.

An example of where to include prepayment information in our loan agreement template

Step 9 – Include Provisions for a Default

When the borrower cannot repay the loan as detailed in the loan agreement, the borrower has entered into default. You should clarify how the borrower will default in the document. Loan agreements can say missing one payment causes a default, but you can be more lenient with the terms as a lender.

Defaulting on a loan can give you the legal right to accelerate payment. In this scenario, you can make the full loan amount due immediately.

An example of where to sign in our business loan agreement template

Step 10 – Add in Relevant Terms

Further terms make up the remainder of the loan agreement and serve to protect the rights of both parties and they include provisions such as:

• The legal right of the lender to enforce the terms of the agreement
• The costs and expenses associated with taking the case to court
• The transferability of the loan agreement
• The capability of alterations to the agreement

Step 11 – Specify How You Would Like To Communicate

You can establish communication methods for yourself and the borrower, so both parties are on the same page. This avoids either party claiming that they didn’t receive a notice.

An example of where to include communication preferences in our loan agreement template

Step 12 – Include Your Resident State

Clearly indicate your resident state in the loan agreement so both parties know which state or jurisdiction laws they must follow.

An example of where to include your resident state or jurisdiction in our loan agreement template

Step 13 – Determine How Disputes Will Be Resolved

Detail the procedure for how both parties can resolve any disagreements. There are numerous options available, ranging from court litigation to mediation. Remember that pursuing court litigation will mean the party who lost the court case will have to pay the other party any costs and fees related to the court process.

An example of where to specify how you would like to handle disputes in our loan agreement template

Step 14 – Include All Relevant Signatures

The parties involved in the loan agreement should sign the agreement. This includes any personal guarantors or co-signers.

An example of where to sign in our loan agreement template

What Should Be Included in a Loan Agreement?

You should always include the following in your loan agreement:

Basic elements

• Borrower: (aka the “buyer” or “payer”) who is receiving the loan from the lender and is responsible for repaying the debt
• Lender: (aka the “issuer”, “maker”, “payee”, or “seller”) who is giving the borrower money and receives the repayment
• Principal amount: the sum of money being borrowed
• Interest: additional money owed, usually a percentage, based on the amount borrowed and time until repayment
• Maturity date: when the money should be repaid

Other details

The contract may also include these provisions:

• Acceleration: whether the lender can increase the repayment date or make the borrower repay the loan immediately. Possible events of acceleration include:
  • If the borrower becomes bankrupt
  • If the borrower fails to make payments
  • If the borrower passes away or the company dissolves
  • If the borrower wants to pay off the note early
  • If the borrower sells off a significant or material portion of their assets
• Amendment: any changes to the agreement, which must be in writing
• Collateral: what property the lender can keep if the borrower defaults
• Governing law: which state laws apply if there is a problem with the agreement
• Joint and several liabilities: states that all of the borrowers are individually responsible for the full amount of the loan
• Late charges: states that the borrower pays the penalty if payment is late
• Prepayment: allows the borrower to pay off the loan and interest early, possibly for a discount
• Right to transfer: allows the lender to transfer the loan to another party

In conclusion, a well-drafted loan agreement is essential for financial transactions, providing legal protection and clarity for both parties involved. Whether you're lending to a friend, family member, or engaging in a business transaction, understanding the nuances of loan agreements is vital. Be vigilant against potential tax implications and predatory lending practices, ensuring that your financial dealings are transparent and legally sound.

Frequently Asked Questions

Can a Loan Agreement be verbal, or does it need to be in writing?

While verbal agreements may have some legal standing, a written Loan Agreement is highly recommended. It provides clear documentation of the terms and serves as a more robust legal foundation, especially in case of disputes.

What are the tax implications of lending or borrowing within family circles?

Lending without interest within family circles may have tax implications. The IRS may impose taxes if the interest is below the minimum Applicable Federal Rate (AFR). It's crucial to understand these implications before entering into family loan agreements.

Loan Agreement Sample