How to Document a Personal Loan Between Family & Friends
Whether you're borrowing from or lending to family and friends, it can be a sensitive financial transaction that poses danger to the relationships.
You're right to avoid any miscommunication by documenting the loan -- both parties agree to whats written on paper.
Let's face it:
If you're lending money, you want to protect yourself in the case of nonpayment.
So, how can you draw up a loan agreement in the event that you need it to take legal action?
You'll have to include certain terms so that you can make your case.
- The importance of documentation
- Key terms to include
- Alternatives loan options
When It Makes Sense
There are a number of reasons that you might want to have a written loan agreement when you borrow money from someone you’re close to.
Offering to have a written agreement when you’re borrowing money can show the person you’re asking for money that you truly intend to pay the loan back.
Without a doubt:
Many people are wary to lend to their friends because they’ll feel awkward about asking you to pay the money back.
Offering additional assurance about your intent to pay can help reduce these concerns.
Setting repayment terms
Another good reason to put your agreement on paper is if you want to create a payment schedule.
If you’re borrowing a lot of money, you might not be able to pay the loan back all at once.
Having a clear payment plan laid out on paper can help you stick to your plan.
You should also have a written agreement if you need to specify any other terms for the loan.
Terms That Should be Specified
If you are making a written loan agreement, there a few terms you may want to specify.
- Total borrowed amount
- Key dates
Note: It is always a smart move to consult a legal professional to help your draw up a proper loan document.
An obvious detail to include in a loan agreement.
This clears up exactly how much was lent.
There will be no confusion on how much was considered a gift while another portion is actually borrowed.
One of the key points of any loan is the interest rate can apply to borrowed balance.
If it's going to be taking a long time to pay the loan back, you might want some compensation for the generous financial assistance.
Charging interest is one way to do this.
These are the common approaches:
- You can calculate it like a typical bank loan does, setting an annual percentage rate that will be charged and calculating interest each day.
- You could also simply add a flat amount to the loan’s balance each month.
In either method, it is best to include the exact payment amount or an example of how the interest is calculated.
It can help prevent disagreements down the road over how interest is charged.
You should also note how payments will be applied towards the balance.
For example, you may want to note that payments will be applied to interest first, and then the principal.
You may also want to note whether overpayment will result in the amount over the standard payment being held until the next payment date, reducing next month’s bill, or if it will be applied directly to the loan’s principal.
Even if you are not charging interest, set a regular repayment amount.
Another thing that you’ll want to write down is important dates related to the loan.
For example, you’ll want to write down the day that the loan was made.
Knowing when the loan was originated is important when calculating interest and determining payment dates.
Another set of dates to note are the days on which payment will be due.
Specifying when you must make payments is essential to making sure you stay on schedule when it comes to paying the loan off. It will also be important to know payment due dates if you want to assess penalties for late payments.
Finally, you should note the day on which the loan should be paid in full.
Writing down the day that the loan will be paid off will help you stay on your payment schedule. It also gives the lender a date on which they can expect to have gotten all of their money back.
Here's the vital part:
You should write down what should happen if the payments are not made as agreed.
While you should always do your best to make the payments you agreed to, sometimes it isn’t possible.
Whether you have another emergency expense that leaves you without enough money to make a payment, or you simply forget, writing out what the consequences will be is important.
One benefit of writing out the consequences of missed payments is that it saves the lender from the awkwardness of having to come after you for payment.
One of the worst parts about lending money to someone you’re close to is having to nag them for the money they owe.
It gets worse when you have to nag someone who is late on paying back a loan, so writing out the consequences saves the lender from that responsibility.
It also prevents the borrower from feeling like the lender is taking advantage of them. If you write out the consequences of missed payments and agree on them before the loan begins, everyone has a say in what those consequences will be.
That can reduce the hard feelings that can result.
Another benefit of writing out the penalties of non-payment is that, in the worst case, a court can enforce those penalties if needed.
Alternatives Loan Options
If you want to avoid loans with a family member or friend, there are some other options you may consider first:
Online personal loans
Personal loans are a great way to borrow money for miscellaneous needs.
Unlike mortgages, which are exclusively for real estate, or car loans, which are for buying a vehicle, personal loans can be used for nearly any purpose.
There are many lenders online that offer personal loans to people across the United States.
What's great about them:
You can find lenders that specialize in small loans of a few thousand dollars and lenders that will offer as much as $100,000 to borrowers.
Many online lenders offer incredibly customizable terms, giving you as little as two years or as many as seven years to pay your loan back.
Some online lenders are able to offer more innovative services than many traditional personal lenders.
Some lenders will look at more than just your credit score and income when making a lending decision.
You may be able to find a lender that will look at your employment history or education when considering your application.
This can help you secure a loan when you otherwise would be able to or to get a lower interest rate.
Online lenders also tend to work fast.
You may be able to get a near immediate decision once you submit your application. If your application is approved, you can get the money delivered in as little as a day.
Secured personal loans
If you don’t feel confident in your ability to get an online personal loan, you can try to get a secured personal loan from a traditional lender.
Secured personal loans, like other personal loans, can be used for nearly any purpose.
Here's the deal:
They’re easier to qualify for because the lender takes on much less risk when lending you the money. The lender’s risk is reduced because you secure the loan with collateral.
When you receive the money, you give the lender something of value, such as money in your savings account or the title to your car. If you pay back your debt, you’ll get the collateral back.
If you miss payments and default on your debt, the lender will take the collateral as compensation.
Because the lender won’t have to go after you to get its money back, it is taking on much less risk. Even if you have poor credit, you might be able to get a secured personal loan if you can come up with the necessary collateral.
Another benefit of secured personal loans is that they charge less interest. Again, this is due to the reduced risk that the lender is taking on.
Getting a loan from a friend or family member can be a sticky situation that leaves both parties unhappy about their relationship.
Documenting the terms of the loan you are receiving can reduce these feelings of uneasiness and help reduce the awkwardness of the situation.
It can also help to keep both parties on track with handling repayment of the loan.