To write a loan letter, put the lender and borrower’s full legal names and addresses on the page, state the exact principal in words and figures, set out the repayment schedule and interest rate, spell out what happens if the borrower defaults, and have both parties sign. That document — also called a promissory note — is what turns a private loan into something a court can enforce and the IRS can recognize as a loan rather than a gift.
The sections below walk through the decisions you need to make first, the clauses the letter has to contain, and the steps that finalize it.
Decide the Terms Before You Draft
Most private loans go wrong because the parties skip this step, write a vague letter, and argue months later about what they actually meant. Settle the following before anything gets typed:
- Both parties’ full legal names as they appear on a driver’s license or passport, and their current mailing addresses.
- The principal — the exact dollar amount changing hands before any interest.
- The repayment schedule. Monthly installments are the most common because they match how people budget. A single lump sum on a future date works when the borrower expects a specific payout, such as a tax refund, an inheritance distribution, or a contract payment.
- Whether the loan carries interest, and if so, at what rate and whether it’s simple or compounded.
- Whether the loan is secured or unsecured. A secured loan ties specific property to the debt — a car, equipment, jewelry — and gives the lender a claim on that property if the borrower defaults. An unsecured loan leaves the lender with only a lawsuit as a remedy. If you’re securing the loan, describe the collateral precisely: make, model, year, and VIN for a car; serial numbers for equipment.
- What counts as default and what follows. The most common provision is an acceleration clause, which makes the entire remaining balance due immediately after a missed payment and a grace period, often 15 to 30 days. Without it, the lender can only sue for each missed payment as it comes.
Setting an Interest Rate That Holds Up
Two separate rules bracket the interest rate: state usury law from above, and federal tax law from below.
Every state caps how much interest you can charge on a private loan. The ceilings vary dramatically. Some states allow rates of 25% or higher depending on the loan type and parties; others set much lower limits; a few impose no statutory cap at all for certain transactions. The common idea that private loans are universally limited to something like 5% to 15% is a misconception. Charging above your state’s usury limit can void the interest entirely and, in some states, trigger criminal penalties. Look up the usury statute in the borrower’s state before settling on a rate.
Now the floor. The IRS publishes minimum interest rates for private loans called Applicable Federal Rates, or AFRs. As of March 2026, the annually compounded AFRs are roughly 3.59% for short-term loans (three years or less), 3.93% for mid-term loans (over three years but not more than nine), and 4.72% for long-term loans (over nine years).1IRS. Rev. Rul. 2026-6 These rates change monthly, so check the revenue ruling in effect when the loan is made.
If your loan charges less than the AFR — including zero — the IRS imputes the difference. The lender owes income tax on interest they never actually received, and the forgone interest may also be treated as a gift from the lender to the borrower. Two exceptions soften this for smaller loans. Gift loans between individuals totaling $10,000 or less are completely exempt from the imputed interest rules, as long as the borrower doesn’t use the money to buy income-producing assets like stocks or rental property.2Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates For gift loans between $10,001 and $100,000, the imputed interest is capped at the borrower’s net investment income for the year, and if that investment income is $1,000 or less, the imputed interest is treated as zero. Above $100,000, the full imputed interest rules apply with no cap.
If forgone interest is treated as a gift, it counts toward the annual gift tax exclusion, which is $19,000 per recipient in 2026.3Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026, Including Amendments From the One, Big, Beautiful Bill On most private loans the imputed amount will fall well below that, but a large, long-term, zero-interest loan can push over the threshold and require the lender to file a gift tax return. Any interest you actually receive is taxable income and gets reported on your federal return regardless of amount.
The simplest way to avoid the imputed interest problem on a family loan is to charge at least the AFR. The rate is modest and it settles the tax question.
What the Loan Letter Needs to Say
With the terms decided, the writing is mostly a matter of putting each piece in the right place. The goal is a document clear enough that a stranger — a judge, for instance — could read it cold and understand exactly what the two of you agreed to.
Put the date at the top; this establishes when the obligation begins. Directly below, identify both parties by full legal name and address, and make clear who is the lender and who is the borrower. Then state the principal in both words and figures, like “five thousand dollars ($5,000.00).” Writing the amount both ways prevents a typo from creating ambiguity about the actual debt.
The repayment section should specify the dollar amount of each installment, the day of the month it’s due, and the date the final payment is expected. If the loan carries interest, state the annual rate and whether it compounds (and how often) or is calculated as simple interest. The difference is real money over the life of a loan, so be explicit.
Include a late-fee provision and your default clause. A typical setup is a flat late fee (say, $25 or 5% of the missed payment) after a 10- or 15-day grace period, and full acceleration of the remaining balance if the borrower falls 30 days or more behind. These provisions aren’t punitive. They’re the reason the document holds up in court if things go sideways.
If the loan is secured, add a collateral section with the detailed description you prepared: make, model, year, VIN, or serial numbers. If it’s unsecured, a single sentence saying so — and confirming that the borrower’s personal obligation to repay is the sole backing — is enough.
If You’re Adding a Co-Signer
When the borrower’s ability to repay is uncertain, a co-signer gives the lender a second person to collect from. Include the co-signer’s full legal name and address in the same identification section as the other parties. Spell out that the co-signer is jointly and severally liable for the full balance. “Jointly and severally” means the lender can pursue either person for the entire amount, not just a proportional share, and can go after the co-signer directly without first trying to collect from the borrower. Add a signature line for the co-signer with language confirming they’ve read the terms and accept full responsibility.
Signing, Notarizing, and Delivering
A promissory note doesn’t have to be notarized to be legally enforceable. In most situations the borrower’s signature alone creates a binding obligation. Notarization is still worth the small cost, typically $2 to $25 per signature depending on the state, with most charging around $5. A notary verifies the signer’s identity and confirms they signed voluntarily, which makes it much harder for someone to later claim the signature was forged or coerced.
For loans involving large sums or parties who don’t know each other well, one or two witnesses add another layer of protection. Witnesses aren’t required for most promissory notes, but their testimony can matter if the borrower challenges the document’s authenticity later. Use neutral adults with no financial stake in the loan.
Both parties should sign two originals so each walks away with a fully executed copy rather than a photocopy. If you can’t sign together in person, send the signed document by certified mail with return receipt service. The return receipt gives verifiable proof of who signed for it and when.4USPS. Certified Mail – The Basics An electronic return receipt does the same job but delivers the proof by email.5USPS. Electronic Return Receipt
Store your copy somewhere secure for the entire life of the loan and at least a few years after final repayment. Tax records related to interest income should be kept for at least three years after the return that reports them. A scanned backup is useful, but courts prefer the original.
Closing the Loan When It’s Paid Off
Once the debt is fully satisfied, the lender should acknowledge it in writing. A short satisfaction letter, sometimes called a release, states that the borrower has paid in full and that the lender releases any further claim. Include the date of final payment, both parties’ names, a reference to the original loan letter by date and amount, and the lender’s signature.
This step mostly protects the borrower. Without a written release, the lender could later claim the debt was never fully repaid. On a secured loan, the release should also return or formally discharge any lien on the collateral so the borrower has clear title. If there was a co-signer, name and discharge them by name as well. Deliver the release the same way you delivered the original loan letter, and keep a copy for your own records.