I Owe You! This Is How to Write a Loan Agreement

I Owe You! This Is How to Write a Loan Agreement

Consumer debt is part and parcel of modern life. In the U.S. alone, the average consumer debt hovers around $96,000 dollars.

Most people have their debt spread out across a range of things, such as car loans, credit cards, student loans, and even retail store cards. Of course, sometimes, people need a loan but can't necessarily get one through traditional means.

If someone you know needs a meaningful loan, you should strongly consider working on a loan agreement. While that might feel overly formal, it can save a lot of trouble.

If you're wondering about how to write a loan agreement or what one even is, keep reading. We'll cover the essentials of loan agreements.

What Is a Loan Agreement?

In essence, a loan agreement functions as a contract between you and the person borrowing money from you. The agreement sets out specific details about the loan, such as the amount and the repayment conditions.

For example, let's say that your brother comes to you and wants to borrow $10,000 to help him launch a business. Unlike a loan for $50 or $100 that you could reasonably write off if you never see it again, most people can't simply absorb a loss of $10,000.

You want a formal agreement in place so that you have some assurance that you'll see that money again at some point. So, the loan agreement will note that you're lending them the $10,000.

The agreement will also set out either specific or general repayment terms. If you're loaning the money to your brother, you might not charge interest on it as a way to be supportive. If you're loaning it to an acquaintance or colleague, you might charge interest.

The agreement will note how much interest you'll charge and at what intervals.

Reasons You Might Need a Loan Agreement

There are a variety of reasons why you might need a loan agreement. You could need one if you intend to lend someone a substantial amount of money or intend to borrow a substantial amount of money from someone.

You might want the agreement as protection for yourself to ensure you get your money back. Additionally, you might want the agreement so that the other person doesn't come back later and try to renegotiate the terms. After all, memory isn't always the best at holding on to the little details.

If you just come to a verbal agreement, you might think you agreed to pay back the loan in two years, and they might remember agreeing to one year. If you put it all down on paper, you can both refer back to it.

It's a protection for everyone involved.

Similarly, if there is interest involved, you don't want an argument down the road over the interest rate.

Things You Want in a Loan Agreement

Loan agreements can range from relatively straightforward to very complex. Regardless of the complexity of the agreement, there are some things you want to make sure to get into any loan agreement. Some common things you want in a loan agreement include:

  • Addresses for both parties
  • Loan amount
  • Interest rate
  • Use Limitations
  • Repayment terms
  • Payment schedule
  • Collateral provided

Most of the things you want to be included are obvious, but a few of the things may seem strange on the surface. Let's dig into a few of those.

Use Limitations

Use limitations can seem strange on the surface. However, a use limitation simply defines how the person borrowing can use the money.

So, if your brother borrows money to help start a restaurant, you could put in a limitation that they must use the money for specific things like equipment or securing a location for the restaurant.

That way, you can ask to see proof down the road that they actually spent the money on the restaurant. If they can't provide proof that they used the money as specified, you could potentially sue them down the road to recoup your losses.

Repayment Terms

Repayment terms aren't strange, in and of themselves, but they can prove strange in practice. When you write up your own loan agreement, you can set the repayment terms in just about any way you want.

Let's return to the loan to your brother for the restaurant. You could make the repayment terms very strict and require monthly payments, like a traditional loan through a bank. On the other hand, you could let them off the hook in the short term and require full repayment of the entire loan at the end of two years.

If you aren't going to use the traditional monthly payment approach, you should detail the specifics of repayment in great detail in the loan agreement.

Should You Write It Yourself?

While you certainly can write a loan agreement yourself, that is a lot of work for not much benefit. You can find a variety of forms for personal loans online.

Many of them are fill-in-the-blank style forms, and some will even let you fill in the details right on the website or in a fillable PDF. The odds are good that this will serve you better than to try writing a loan agreement yourself.

Is It Binding?

As a general rule, yes, loan agreements between individuals are legally binding. For your own protection, though, you should strongly consider getting the document notarized. It serves as a kind of proof that everyone signed the document at a specific point in time.

How to Write a Loan Agreement With Care

When it comes to the problem of how to write a loan agreement, the most important thing is that you write it with care. Get the specifics into the document, such as the people involved, the amount, and the repayment terms.

In practical terms, though, you really aren't any better served by writing your own loan agreement. You can save yourself a lot of time and mental grief by using an existing loan agreement form and filling in the details on that form.

Looking for more financial tips? Check out the posts in our business section.

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