Personal Loan Agreement: What to Include and How to Write One

Your brother needs $3,000 for a car repair. Your best friend needs rent covered until payday. You say yes, maybe with a handshake or a nod, because that's what people who care about each other do.

The trouble starts later. Memory shifts. Expectations quietly change. A verbal promise that felt solid in the moment can end up meaning two different things to two different people.

A short written agreement closes that gap before it opens. It puts what you already agreed to in writing, so it's there when memory isn't enough. 

What is a personal loan agreement?

A personal loan agreement is a written contract between a lender and a borrower. It lays out the loan amount, interest rate, repayment schedule, and what happens if either side falls behind. Both sides sign it.

Most personal loan agreements happen between family members or close friends, not banks and customers. A bank sets its own fixed conditions. A private agreement, once you understand how personal loans work, leaves those decisions up to the two people involved. 

A handshake or a text confirming a loan isn't the same as a signed agreement. If a disagreement comes up, a written document gives both people something concrete to point to. A verbal promise doesn't.

If a private loan between family or friends isn't a clear fit yet, comparing the best personal loans on the market is worth a look before you draft anything.

What to include in a personal loan agreement

Every personal loan agreement should cover eight things, whether you write it from scratch or start from a template. Skip one, and you leave room for confusion down the road.

• Parties and addresses: Full legal names and current addresses for both the lender and the borrower.
• Loan amount: The exact dollar amount being borrowed, stated in numbers and words if you want extra clarity.
• Interest rate: State whether the loan is interest-free or carries a rate, and how that rate applies. A personal loan calculator can help you work out a monthly payment once you settle on a rate.
• Repayment schedule: How much is due, how often, and the date of the final payment.
• Late fees: What happens, if any, when a payment is late: a flat fee, a short grace period, or no penalty at all. Decide this before it happens, not after.
• Security or collateral: Whether the borrower is putting up an asset, like a car title or a piece of property, to back the loan. Most family and friend loans skip this, but it's worth deciding on purpose rather than by default.
• Signatures: Both parties should sign and date the document.
• Governing law: Which state's law applies if a disagreement ever needs to go to court. This typically matches wherever the lender or borrower lives.

A single page covering these eight points is often enough for a loan between two people who already trust each other.

Loan agreement vs. promissory note vs. IOU—which do you need?

An IOU, a promissory note, and a personal loan agreement all confirm that one person owes another money, but they're not the same.

An IOU is the simplest of the three. It says that a debt exists, without laying out repayment terms. It's a starting point for tracking a small, informal debt, not something built to survive a real dispute.

A promissory note is a step up: a written promise to repay that spells out the amount, the timing, and the interest rate. It commonly needs only the borrower's signature.

A personal loan agreement is the most complete option. It covers the same ground as a promissory note, plus collateral, what happens if the borrower doesn’t repay, and other items. Both parties sign it.

For a small loan between people who already trust each other, a promissory note is often enough. For a larger sum or a loan with genuine dispute risk or collateral, the fuller agreement is worth the extra step.

How interest and IRS rules apply to loans between family or friends

You're not required to charge interest on a personal loan agreement between family or friends. Many people don't.

Skip it, or set the rate too low, and the IRS could step in. The government publishes an Applicable Federal Rate (AFR) each month, and a lender who charges less than that rate can trigger the below-market loan rules under IRC §7872. Under those rules, the IRS treats the forgone interest as if the lender received it, and in some cases, as a gift from the lender to the borrower.

There's an exception: gift loans totaling $10,000 or less between the same two individuals are exempt from this rule, so long as the borrower didn’t use the loan to buy an income-producing asset, like a rental property or investment.

Because the AFR changes every month, check the IRS Applicable Federal Rates page directly before you settle on a rate for a larger loan.

Secured vs. unsecured personal loans

Most personal loans are unsecured, but secured options exist. A secured loan is backed by collateral, an asset the lender can claim if the borrower stops paying.

Collateral gives the lender something to fall back on, which is why banks routinely ask for it on larger loans. Between family and friends, though, most loans stay unsecured. Attaching collateral to a private loan can feel unfriendly, and for a smaller loan, it's rarely worth the paperwork.

Securing a loan makes more sense as the amount grows, or when the money purchases a specific asset. For a loan to help someone buy a car, the car itself could serve as collateral. To compare a private loan against other options, different types of personal loans, including family loans lays out the alternatives side by side.

Whichever you choose, put it in writing. An unsecured loan is still a loan, and the agreement should say so plainly.

What happens if the borrower can't pay

Decide what happens if a payment is missed before it happens, not after. Spell out any late fee, a grace period if you're offering one, and what counts as default, such as missing two payments in a row.

Deciding this in advance is kinder to the relationship than improvising in the moment. Nobody has to guess what the other person is thinking, or feel like the rules changed after the fact.

If repayment breaks down completely, small claims court is a last resort. The amount you can sue for varies by state, so check your state's limit before assuming it applies. A written agreement also makes that option realistic; a court has a harder time enforcing a debt nobody wrote down.

If you forgive the loan instead of collecting it, the canceled amount typically counts as taxable income for the borrower. An IRS exclusion, such as insolvency, could change that.

If the friend's credit makes you too nervous to help them, a bad credit personal loan might get them what they need without risking your friendship.

How to finalize and sign the agreement

Both people read the full document before signing, not only the parts that apply to them. Each person signs and dates it, and each side keeps a copy for their own records.

If you use a template, double check that every blank is filled in, and that the names, the amount, and the repayment schedule all match what you actually agreed to.

For a larger loan, adding a notary or a witness can bring an extra layer of protection, though it's not typically required for the agreement to be valid. Notary rules vary by state, so check what applies where you live before assuming you need one.

That's it. A signed agreement with a copy on each side turns a private understanding into something you can point to later, if you ever need to.

Bills Action Plan

1. List the loan amount, interest (if any), and repayment schedule before you write anything else.

2. Draft the agreement together, using a template or from scratch, and have both people read the full document before signing.

3. Sign, date, and keep a copy each; consider notarizing if the amount is significant.

Key Terms

Personal loan agreement: A written contract between a lender and a borrower that spells out the loan amount, interest rate, repayment schedule, and what happens if the borrower falls behind.

Promissory note: A simpler, shorter document where the borrower promises to repay a debt. It's commonly used instead of a full loan agreement for smaller, lower-risk loans.

IOU: The simplest way to put a debt in writing. It confirms that one person owes another money, without spelling out repayment terms like timing or interest.

Collateral: Property or an asset a borrower agrees to give up if they don't repay the loan, used in a secured loan.

Unsecured loan: A loan backed only by the borrower's promise to repay, with no collateral attached.

Default: When a borrower misses a payment or otherwise breaks the terms of the loan agreement.

Applicable Federal Rate (AFR): The minimum interest rate the IRS publishes each month; loans charging less than this rate can trigger tax rules on the difference.

This is general information, not legal or tax advice. Consult an attorney or tax professional for guidance specific to your situation.