To write a personal loan agreement, put the following in writing and have both sides sign it: the full legal names and addresses of lender and borrower, the principal amount, the effective date, an interest rate that sits above the IRS Applicable Federal Rate and below your state’s usury cap, a repayment schedule with a maturity date, default and late-fee terms, any collateral, and signatures. Skip any of these and you weaken either enforceability in court or your position with the IRS, which may treat the transfer as a gift rather than a loan.
Name the Parties Precisely
Use full legal names as they appear on a government-issued ID like a driver’s license or passport. Nicknames and shortened names create ambiguity that can undermine enforcement later. List each person’s current residential address underneath their name. That address establishes where legal notices can be sent and helps determine which state’s laws govern if the agreement ends up in court.
Each party should also have their taxpayer identification number on hand, typically a Social Security number. You don’t need to write it into the body of the agreement, but you will need it if the lender reports interest income or if the IRS questions whether the transfer was a loan at all.
State the Loan Amount and Effective Date
Write the principal in both words and numerals: “Five Thousand Dollars ($5,000.00).” Writing it both ways prevents disputes about altered figures. The effective date marks when obligations begin and interest starts running. If the money will be disbursed in installments rather than a lump sum, list each disbursement date and amount separately.
The effective date also starts the clock on the repayment schedule and, eventually, the statute of limitations if you ever need to sue. Fill in every blank precisely so the borrower cannot later argue the contract is too vague to hold up.
Set an Interest Rate Between the Floor and the Ceiling
A private loan’s interest rate has both a ceiling and a floor, and you have to land between them.
The ceiling comes from state usury laws, which cap what a non-institutional lender can charge. These caps vary but commonly fall between 6% and 12% per year for private loans. Charging above your state’s limit can void the interest entirely or expose the lender to penalties, so check your state’s usury statute before settling on a number.
The floor comes from federal tax law. Charge less than the IRS Applicable Federal Rate and the IRS treats the difference as “imputed interest”: the lender owes income tax on interest they never actually collected. The AFR changes monthly and depends on loan length. For a loan originated in February 2026, the annual compounding AFR was 3.56% for short-term loans (three years or less), 3.86% for mid-term loans (over three years up to nine years), and 4.70% for long-term loans (over nine years).1IRS.gov. Applicable Federal Rates for February 2026 (Rev. Rul. 2026-3) Check the IRS AFR page for the rates in effect the month your loan is made.2Internal Revenue Service. Applicable Federal Rates Rulings
Pick a rate above the current AFR and below your state’s usury cap. State it clearly, specify whether it’s simple or compound interest, and note how it’s calculated: daily, monthly, or annually.
Know the Federal Tax Rules Before You Set Terms
Under federal law, any loan where interest is below the AFR is a “below-market loan,” and the IRS will treat the forgone interest as though the lender gifted it to the borrower and the borrower paid it back as interest.3Office of the Law Revision Counsel. 26 U.S. Code 7872 – Treatment of Loans With Below-Market Interest Rates Both sides can end up with tax consequences for money that never changed hands.
Two exceptions matter for small family loans. Loans of $10,000 or less between individuals are completely exempt from the imputed interest rules, as long as the borrower doesn’t use the money to buy investments or other income-producing assets. For loans between $10,001 and $100,000, the imputed interest is capped at the borrower’s actual net investment income for the year; if the borrower has no investment income, the imputed interest is zero.3Office of the Law Revision Counsel. 26 U.S. Code 7872 – Treatment of Loans With Below-Market Interest Rates Once the outstanding balance between the two people exceeds $100,000, that cap disappears and the full imputed interest applies.
Avoid Gift Recharacterization
If the IRS decides your supposed loan was never a real debt, it can reclassify the entire amount as a gift. The IRS looks at whether the agreement contains genuine repayment terms, whether the borrower actually makes payments, whether interest is charged, and whether the lender does anything when payments are missed. A written agreement with a market interest rate, a fixed repayment schedule, and actual payment history is your strongest defense.
In 2026, the annual gift tax exclusion is $19,000 per recipient.4Internal Revenue Service. Frequently Asked Questions on Gift Taxes If a loan is recharacterized and the amount exceeds $19,000, the lender may owe gift tax or at minimum must file a gift tax return.
Interest Income Reporting
The lender must report all interest received as income on their federal tax return, regardless of the amount. A private individual lender does not need to file a Form 1099-INT for interest received on a loan issued by another individual, because the IRS exempts interest on obligations issued by individuals from that reporting requirement.5Internal Revenue Service. Instructions for Forms 1099-INT and 1099-OID The tax obligation on the income remains regardless.
Build the Repayment Schedule
Specify how often payments are due (monthly on a fixed date, biweekly, quarterly) and the exact dollar amount of each payment. If the loan carries interest, break down how much of each payment goes toward principal versus interest, or at minimum note the calculation method. A borrower paying $200 per month on a $5,000 loan at 5% should be able to look at the agreement and see how the balance winds down.
Set a maturity date, when the entire remaining balance becomes due. Without one, the loan turns into an open-ended obligation that is harder to enforce and leaves neither side clear on when the arrangement ends.
Address prepayment. State whether the borrower can pay off the loan early without penalty. Federal law prohibits prepayment penalties on private education loans, but no blanket federal prohibition covers general private loans between individuals.6Office of the Law Revision Counsel. 15 USC 1650 – Preventing Unfair and Deceptive Private Educational Lending Practices Most private personal loans allow prepayment without penalty, and an explicit prepayment clause prevents arguments later.
Write Default and Late Fee Provisions
This is where personal loan agreements between friends fail most often, because no one wants to plan for the uncomfortable scenario. Do it anyway. Define exactly what counts as default: a payment missed by 10 days, 15 days, or 30 days past the due date.
Include an acceleration clause. This gives the lender the right to demand the full remaining balance immediately after a default rather than suing over each missed installment one at a time. Without it, a lender whose borrower stops paying is stuck filing repeated claims or waiting until the maturity date to demand everything at once.
Late fees should be a specific dollar amount or a small percentage of the missed payment. Most states that cap late fees limit them to around 5% of the overdue installment. Keep the fee reasonable; courts can void late fees that look like penalties rather than compensation for the inconvenience. A $25 flat fee or 5% of the missed payment sits within the range most courts will enforce.
Add Collateral If the Amount Warrants It
Not every personal loan needs collateral, but for larger amounts, a security interest gives the lender a way to recover money beyond suing for breach of contract. If the loan is secured, describe the collateral specifically enough that a court could identify and seize it.
For a vehicle, include the Vehicle Identification Number, make, model, and year. Listing a lien on the vehicle title through your state’s motor vehicle agency is the only way to perfect a security interest in a titled vehicle. A UCC-1 financing statement filed with the Secretary of State won’t do it for vehicles because state certificate-of-title statutes take priority.7Legal Information Institute. UCC 9-311 – Perfection of Security Interests in Property Subject to Certain Statutes, Regulations, and Treaties Contact your state’s DMV or equivalent agency to add the lender as a lienholder on the title.
For other personal property like equipment, jewelry, or electronics, describe the item with serial numbers or other identifying marks. To get priority over other creditors, file a UCC-1 financing statement with the Secretary of State in the state where the borrower is located. Filing typically costs between $10 and $25 and is valid for five years. The statement needs the names of both debtor and secured party plus a description of the collateral. Getting the borrower’s legal name wrong can render the filing ineffective.
Sign, Execute, and Store the Agreement
A personal loan agreement does not need to be notarized to be legally binding. It does need signatures from both parties confirming they’ve read and agreed to every term. Notarization adds protection by having a neutral third party verify the identity of each signer and place an official seal on the document. If the borrower later claims they never signed or that someone forged the signature, a notarized agreement is much harder to challenge.
Witnesses serve a similar purpose. One or two witnesses present at signing can later testify that both parties voluntarily signed. Some lenders use both witnesses and notarization for higher-value loans, though neither is legally required in most states for the agreement to be enforceable.
Electronic signatures are legally valid under the federal E-SIGN Act, which gives electronic records and signatures the same legal weight as paper and ink for most transactions.8NCUA. Electronic Signatures in Global and National Commerce Act (E-Sign Act) Platforms that capture timestamps and identity verification are acceptable.
After signing, give each party an original executed copy and store yours somewhere secure and accessible. A fireproof safe or safety deposit box works. The point is to have the document available if a dispute arises years later.
If the Lender Later Forgives the Debt
If the lender decides to forgive part or all of the outstanding balance, the forgiven amount is generally taxable income to the borrower. This catches people off guard in family situations where forgiveness is viewed as a favor rather than a tax event.
Private individual lenders are not required to file Form 1099-C when they cancel a debt; that filing obligation falls on financial institutions and organizations whose significant trade or business is lending money.9Internal Revenue Service. Instructions for Forms 1099-A and 1099-C The borrower’s tax obligation exists whether or not a 1099-C is filed. If the forgiven amount exceeds $19,000 in a single year, the lender may also need to file a gift tax return.4Internal Revenue Service. Frequently Asked Questions on Gift Taxes
If You Have to Enforce It
If the borrower stops paying, the lender’s first step is usually a written demand letter referencing the specific terms of the agreement. If that fails, the lender can file a lawsuit for breach of contract.
For smaller loans, small claims court is often the fastest and cheapest option. Filing limits vary by state but generally range from $3,000 to $20,000. You typically don’t need a lawyer in small claims court, and the written agreement serves as your primary evidence. For amounts above the small claims limit, you’ll need to file in a higher court, which usually means hiring an attorney.
Every state imposes a statute of limitations on breach-of-contract lawsuits. For written contracts these deadlines typically range from three to ten years, with most states falling in the three-to-six-year range. The clock generally starts running from the date of the last missed payment or the maturity date. Making a partial payment or signing a new acknowledgment of the debt can restart the clock in some states. If you wait too long, the court will dismiss the case regardless of how strong your evidence is.
If the Borrower Files Bankruptcy
A private personal loan is generally dischargeable in bankruptcy, meaning the borrower may be released from the obligation to repay. Private loans between individuals don’t fall into the protected categories like child support, most taxes, or student loans that survive bankruptcy. One exception: if the borrower obtained the loan through fraud, false pretenses, or a materially false financial statement, the lender can ask the bankruptcy court to exclude the debt from discharge. That request must be filed affirmatively by the lender during the bankruptcy proceedings, or the debt is discharged by default.10United States Courts. Discharge in Bankruptcy – Bankruptcy Basics
Collateral offers some protection. A properly perfected security interest means the lender’s claim on the collateral survives even if the personal obligation to repay is discharged. That’s another reason to take the extra step of filing a UCC-1 or recording a lien on a vehicle title when the loan amount justifies it.