How to Write a Loan Agreement: Terms, Collateral, and Default

A loan agreement is a written contract between a lender and a borrower that records how much is being lent, what interest applies, when it must be paid back, and what happens if it isn’t. To write a loan agreement that will actually hold up, you need a handful of specific pieces: the full identities of everyone involved, the principal, the interest rate, a repayment schedule with firm dates, default and acceleration rules, any collateral terms, a governing-law clause, and proper signatures. Get those right and an informal promise becomes an enforceable contract.

A verbal promise about repayment is difficult to prove and harder to enforce. Putting the terms on paper protects both sides.

Identify the Parties

Start with each person’s full legal name as it appears on a government-issued ID, along with a current physical address. Skip P.O. boxes. The address establishes where legal notices can be delivered and helps determine which state’s laws govern the deal. Label each person clearly at the top of the document as either “Lender” or “Borrower” so there’s no ambiguity about who’s handing over the money and who’s receiving it.

If a co-borrower or a guarantor is signing on — someone who promises to pay if the primary borrower can’t — identify them with the same detail and spell out their role.

State the Loan Amount

The principal is the total sum the lender is providing. Write it in both figures and words, like “$15,000 (Fifteen Thousand Dollars),” so a typo in one format doesn’t create an argument about the real number. If the money will be released in stages instead of all at once, describe the schedule and the conditions attached to each disbursement.

Keep a paper trail that matches the stated principal: a bank statement, wire-transfer confirmation, or canceled check. That record settles any later disagreement about what actually moved.

Set the Interest Rate

The agreement should say whether interest is charged and, if so, the exact annual rate. Interest can be simple (calculated only on the remaining principal) or compound (calculated on the principal plus accrued interest). Specify which, because the total cost to the borrower can swing meaningfully between the two.

Every state sets its own ceiling on allowable rates through usury laws. There’s no single federal cap for all private loans, so the maximum depends on the state whose law governs. Charging above the legal limit can void the interest portion of the agreement, and some states impose further penalties on the lender, including forfeiture of all interest or even the principal. Check the usury statute in the governing state before you settle on a rate.

IRS Rules for Family and Friend Loans

If you lend money to someone at a rate below the IRS’s Applicable Federal Rate (AFR), or charge no interest at all, the IRS may treat the missing interest as a taxable gift from lender to borrower. This is called imputed interest, and it applies to what the tax code calls below-market loans.¹

The AFR changes monthly. For January 2026, the minimum annual rates compounded annually run about 3.63 percent for short-term loans (three years or less), 3.81 percent for mid-term loans (over three years up to nine years), and 4.63 percent for long-term loans (over nine years).² Charging at least the AFR for the correct term avoids imputed-interest problems entirely.

Two exceptions ease things for smaller personal loans:

$10,000 de minimis rule. If the total you’ve lent to one person is $10,000 or less, the imputed-interest rules generally don’t apply, unless the borrower uses the money to buy income-producing assets or the loan is structured to avoid taxes.¹
$100,000 net-investment-income cap. For loans between individuals totaling $100,000 or less, imputed interest attributed to the borrower is capped at the borrower’s actual net investment income for the year. If that investment income is $1,000 or less, it’s treated as zero.¹

When imputed interest on a gift loan exceeds the annual gift-tax exclusion, which is $19,000 per recipient for 2026, the lender must file IRS Form 709, the gift-tax return, even if no gift tax is actually owed.³⁴

Spell Out the Repayment Schedule

Two dates anchor the agreement. The effective date is the day the lender transfers the money and the contract takes effect. The maturity date is the final deadline for full repayment of principal and remaining interest. A five-year term runs exactly sixty months from the effective date. Put both dates in writing so there’s no guesswork about when the clock starts or when the borrower has to be done.

Between those two dates, describe exactly how payments work. Common structures include a single lump sum at maturity, equal monthly or quarterly installments, or interest-only payments with a balloon payment of the remaining principal at the end. Whichever you pick, list the payment amount, the frequency, and the due date for each cycle.

Grace Periods

A grace period gives the borrower a short window after the due date, often five to fifteen days, to pay without triggering a late fee or default. It cuts friction over small delays from mail, bank processing, or forgetfulness. If you include one, state the exact number of days and clarify that payment must be received, not just mailed, within that window.

Late Fees

Late fees compensate the lender for the hassle of chasing overdue payments. Courts generally treat them as pre-agreed damages, so the amount has to be reasonable relative to the lender’s actual costs. A fee that looks more like punishment than a cost estimate can be struck down as an unenforceable penalty. Common approaches: a flat dollar amount like $25 or $50, or a small percentage of the overdue payment, typically 3 to 5 percent. Spell out the amount, when it kicks in, and whether the grace period runs first.

Prepayment

Say whether the borrower can pay off the loan early, and whether any prepayment fee applies. Prepayment fees compensate the lender for interest income lost when a loan is retired ahead of schedule. For certain high-cost mortgage loans, federal law prohibits prepayment penalties entirely.⁵ Even where they’re legal, many private loan agreements waive them. Address the topic either way so neither side is surprised.

Address Collateral if the Loan Is Secured

A secured loan is backed by specific property, such as a car, equipment, real estate, or a financial account, that the lender can claim if the borrower stops paying. An unsecured loan has nothing pledged, which raises the lender’s risk and may justify a higher rate. If collateral is part of the deal, give it its own section.

Describe the Collateral Specifically

Under Article 9 of the Uniform Commercial Code, the description has to “reasonably identify” the property. A vague reference like “all of the borrower’s assets” is not enough for a security agreement.⁶ Use identifying details: the VIN for a car, the serial number for equipment, or the legal description from a deed for real property.

Make the Security Interest Enforceable

Three things must happen for a security interest to attach, meaning it becomes legally enforceable against the borrower:

Value given. The lender has provided the loan funds.
Borrower’s rights. The borrower owns or has the legal right to pledge the collateral.
Signed agreement. The borrower has signed, or electronically authenticated, a security agreement that describes the collateral.⁶

Perfect the Interest With a UCC-1 Filing

Attachment protects the lender against the borrower, not against other creditors who might also claim the same property. To establish priority, the lender files a UCC-1 financing statement with the Secretary of State’s office in the state where the borrower is located. The filing puts other creditors on public notice that the property is already pledged. Skip this step, and a creditor who did file may have a superior claim if the borrower defaults with multiple creditors. For real property used as collateral, the lender typically records a deed of trust or mortgage with the county recorder’s office instead.

Define Default and Acceleration

The default clause is the enforcement backbone of the agreement. It defines what counts as a breach, and what the lender can do about it. A simple provision might say the borrower is in default if any payment is unpaid a set number of days after the due date, often 30. Many agreements add other triggers: failing to maintain insurance on the collateral, providing false information in the agreement, or filing for bankruptcy.

Acceleration

An acceleration clause lets the lender demand the entire remaining balance once a default occurs, not just the missed payments. Without the clause, the lender can only pursue each installment as it comes due. When acceleration is tied to the lender’s judgment that repayment is at risk, that power has to be exercised in good faith, not on a whim.

Notice and a Cure Period

Before accelerating, suing, or seizing collateral, the agreement should require the lender to send a written notice of default. The notice tells the borrower what went wrong, how much is owed, and how long they have to fix it. A cure period of 15 to 30 days is common. These steps protect the lender from accusations of acting too hastily and give the borrower a fair chance to catch up.

Attorney Fees and Collection Costs

Many agreements shift the cost of enforcement — attorney fees, court filing fees, and collection expenses — to the borrower in a default. Without such a clause, each side generally pays its own legal costs even if the lender wins. If you include one, write it clearly enough that a court will uphold it. Some states regulate these fee-shifting provisions, so check local rules before finalizing.

Choose a Governing Law and Watch the Statute of Limitations

A governing-law clause names the state whose law applies to the agreement. This matters most when the lender and borrower live in different states, because interest-rate limits, default remedies, and statutes of limitations can all vary. Courts generally honor the parties’ choice, but the state picked should have a real connection to the loan, such as being where one party lives or where the money was disbursed. A choice with no connection to the transaction may be challenged.

The statute of limitations is the deadline for suing to collect on an unpaid debt. For written contracts, the period runs from roughly 3 years in some states to 10 years or more in others. Once it passes, the lender generally loses the right to sue, even if the borrower clearly owes the money. The governing-law clause can affect which state’s deadline applies, which is another reason to pick it carefully. If you’re the lender, track the maturity date and any missed payments closely so you don’t accidentally run out of time to take action.

When Federal Lending Disclosures Apply

Casual lenders, like someone helping a relative buy a car or lending a friend startup money, generally aren’t covered by the federal Truth in Lending Act (TILA) and its implementing Regulation Z. Those rules apply only to “creditors,” and you become one under TILA only if you extended consumer credit more than 25 times in the prior calendar year. For loans secured by a home, the threshold drops to more than 5 times in the prior year.⁷

Cross those thresholds and Regulation Z requires specific written disclosures before signing, including the annual percentage rate (APR), the finance charge in dollars, the total amount financed, and the total of all payments over the life of the loan.⁸ Even if TILA doesn’t apply, including these figures helps the borrower see the true cost of the loan and heads off disputes later.

Sign and Store the Agreement

Every party should sign and date the same document. Signatures turn the written terms into a binding contract. A loan agreement is generally valid with signatures alone, but a few extra steps head off future problems.

Notarization

A notarized signature means a licensed Notary Public verified the signer’s identity, usually by checking a government ID, and stamped the document with an official seal. That makes it much harder for a party to later claim the signature was forged or that someone else signed.

Witnesses

Two disinterested witnesses, people with no financial stake in the loan, add another layer of proof that the signing actually happened. Each witness signs and provides a printed name and address. Most states don’t require witnesses for a standard loan agreement, but they’re useful when the agreement isn’t notarized.

Electronic Signatures

Federal law treats electronic signatures as legally equivalent to ink-on-paper signatures for most commercial transactions, including loan agreements.⁹ The electronic record has to be stored in a format every party can retain and reproduce accurately later. A few categories are carved out — wills, certain family-law matters, court orders, and notices of default or foreclosure on a primary residence — but a standard personal loan agreement isn’t among them.¹⁰

Storing the Signed Agreement

Once executed, keep the original in a secure place: a fireproof safe, a locked filing cabinet, or an encrypted digital vault. Every party should receive a complete copy. If the loan is secured, the lender may also need to file the UCC-1 or record a deed of trust. Keep the document accessible; disputes can surface years after the loan was made.

1
Office of the Law Revision Counsel. 26 U.S. Code 7872 – Treatment of Loans With Below-Market Interest Rates
2
Internal Revenue Service. Revenue Ruling 2026-2
3
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
4
Internal Revenue Service. Gifts and Inheritances
5
Office of the Law Revision Counsel. 15 U.S. Code 1639 – Requirements for Certain Mortgages
6
Cornell Law School. UCC 9-203 – Attachment and Enforceability of Security Interest
7
Federal Register. Truth in Lending (Regulation Z) Consumer Protections for Home Sales Financed Under Contracts for Deed
8
eCFR. 12 CFR Part 1026 – Truth in Lending (Regulation Z)
9
Office of the Law Revision Counsel. 15 U.S. Code 7001 – General Rule of Validity
10
Office of the Law Revision Counsel. 15 U.S. Code Chapter 96 – Electronic Signatures in Global and National Commerce