To write a promissory note for a personal loan, put the following on paper and sign it: the full legal names and addresses of the lender and borrower, the exact principal amount, the interest rate and how it’s calculated, the repayment schedule with a firm maturity date, what happens if the borrower pays late or defaults, which state’s law governs the note, and the date of signing. Get those elements right and an informal loan becomes an enforceable contract. Miss the tax rules that apply to loans between individuals, and you can owe income tax on interest you never actually collected.
The Core Terms Your Note Must Contain
A promissory note is enforceable when it contains an unconditional promise to pay a fixed sum, is payable on demand or at a definite time, and is payable to a specific person or to the bearer.1LII / Legal Information Institute. UCC 3-104 – Negotiable Instrument Build your draft around these items:
- Full legal names and current residential addresses of both parties. Nicknames and initials invite identity disputes.
- The principal amount written in both words and numerals.
- The interest rate, along with whether it is simple or compound.
- The date the loan is made or funded.
- Repayment terms: how and when the borrower pays, and the maturity date by which the balance must be gone.
- A governing-law clause naming the state whose rules control the note. Skip this when the parties live in different states and you invite a fight over which law applies.
Both signers need to be legal adults with the mental capacity to understand what they’re agreeing to. In most states, a contract signed by someone under 18 can be voided by that person, and a signer who lacked the cognitive ability to understand the terms at signing can later challenge the note’s validity.
How to Set the Interest Rate Legally
Every state sets a maximum interest rate for private loans, and these caps vary widely. Some states cap rates as low as 6%; others allow 30% or more; a few impose no general cap at all. Before you pick a number, look up the usury limit in the state whose law will govern your note. Charging more than the legal maximum can void the interest entirely, and in some states the lender can lose the right to collect the principal too.
Simple vs. Compound Interest
Simple interest is charged only on the original principal. A $10,000 loan at 5% simple interest for three years produces $1,500 in interest, $500 each year. Compound interest is charged on the principal plus previously accrued interest, so the balance grows faster. Simple interest is more common between individuals and easier to verify. If you go with compound interest, name the compounding frequency (monthly, quarterly, annually) in the note. And whichever you choose, write it down. A note that says only “5% interest” is asking for an argument later about what that meant.
How the Loan Gets Repaid
Three repayment structures cover almost every personal loan:
- Lump sum. The borrower pays principal and interest together on a single date. This fits short-term loans where a specific event, like a tax refund or bonus, will fund repayment.
- Installments. The debt is spread over regular, usually monthly, payments. State the exact amount of each payment, the day it is due, and where to send it. Include a maturity date so there’s a hard deadline even if the schedule slips.
- Demand. The lender can call the entire balance due at any time. This gives the lender flexibility but requires the borrower to stay liquid.2LII / Legal Information Institute. Demand Note
For installment loans, spell out how each payment is applied: interest first, then principal. Without that instruction, a dispute over the remaining balance is nearly guaranteed.
What Happens if the Borrower Defaults
A note without default provisions is a contract without consequences. Four items belong in this part of the document.
Late Fees
Late fees are usually a percentage of the missed payment, often around 5%. State the grace period, commonly 10 to 15 days after the due date, before a fee applies. Keep the fee reasonable. Courts in many states refuse to enforce charges that look more like punishment than compensation.
Acceleration Clause
An acceleration clause lets the lender declare the entire remaining balance immediately due on default. Without one, a lender on an installment note has to chase each missed payment on its own. With one, a material breach like several consecutive missed payments triggers the right to demand everything at once. When acceleration is invoked, the borrower owes the unpaid principal plus interest accrued up to that point, not the full interest that would have come due over the rest of the term.3LII / Legal Information Institute. Acceleration Clause
Attorney Fees
If you want the borrower to cover legal costs in a collection lawsuit, say so in the note. Without an express provision, each side generally pays its own attorney fees. A standard clause states that the defaulting party pays reasonable attorney fees and court costs to enforce the note. Courts will often trim excessive fee terms, so “reasonable” language holds up better than a fixed percentage.
Prepayment
Decide upfront whether the borrower can pay off the loan early without penalty. Most personal loans between individuals allow prepayment for free. If you’re counting on the interest income, you can include a prepayment penalty, but state clearly whether it’s a flat fee or a percentage of remaining interest.
Whether to Secure the Loan With Collateral
An unsecured note is backed only by the borrower’s promise. If they default, the lender’s recourse is a lawsuit and, if it succeeds, trying to collect on a judgment. A secured note ties the loan to specific property, such as a vehicle, a piece of equipment, or a savings account. If the borrower defaults, the lender has a claim on that property.
When you secure the note, describe the collateral specifically enough that no one has to guess what it is: make, model, year, and VIN for a vehicle; serial numbers for equipment; account numbers for financial assets. Vague descriptions like “my car” weaken the security interest. Depending on the type of collateral and your state’s rules, you may also need to file a UCC financing statement to perfect that interest, meaning your claim is formally recorded and takes priority over other creditors.
IRS Rules for Loans Between Individuals
This is where people lending to family or friends most often get caught out. The IRS doesn’t let you lend interest-free or at an artificially low rate without tax consequences.
Applicable Federal Rate and Imputed Interest
Under federal tax law, when a loan between individuals charges less than the applicable federal rate (AFR), the IRS treats the difference as imputed interest. The lender is taxed as though they collected interest at the AFR, and the forgone amount may be treated as a gift from lender to borrower.4Office of the Law Revision Counsel. 26 U.S. Code 7872 – Treatment of Loans With Below-Market Interest Rates The AFR is published monthly by the IRS and depends on the loan’s term:
- Short-term (3 years or less): 3.59% for March 2026
- Mid-term (over 3 years, up to 9 years): 3.93% for March 2026
- Long-term (over 9 years): 4.72% for March 2026
These rates assume annual compounding and change each month.5Internal Revenue Service. Revenue Ruling 2026-6 The rate in effect on the day you make a term loan applies for the life of that loan. For demand loans, the rate resets each period.
The $10,000 De Minimis Exception
If the total outstanding loan amount between two individuals stays at or below $10,000, the imputed interest rules don’t apply.4Office of the Law Revision Counsel. 26 U.S. Code 7872 – Treatment of Loans With Below-Market Interest Rates The exception disappears if the borrower uses the money to buy income-producing assets like stocks or rental property. For loans between $10,000 and $100,000, imputed interest is capped at the borrower’s net investment income for the year, which limits exposure on modest family loans.
Reporting Interest You Receive
Any interest you collect on a personal loan is taxable income, whether or not you receive a Form 1099-INT. You must report it on your federal return regardless of amount.6Internal Revenue Service. Topic No. 403 – Interest Received If you receive $10 or more in interest from a single borrower during the year, the borrower is technically required to file Form 1099-INT for that payment.7Internal Revenue Service. Instructions for Forms 1099-INT and 1099-OID Most individuals lending to family don’t issue the form, but the income is still taxable.
Gift Tax if You Forgive Part of the Loan
Forgiving part or all of a loan turns the forgiven amount into a gift. The same applies to imputed interest on a below-market loan. For 2026, the annual gift tax exclusion is $19,000 per recipient, so forgiven amounts under that threshold don’t require a gift tax return.8Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 Larger forgiveness requires filing Form 709, though it rarely triggers actual gift tax thanks to the lifetime exemption.
Signing, Notarizing, and E-Signing
A promissory note doesn’t need to be notarized to be enforceable. The borrower’s signature alone makes it binding. Notarization adds proof that the person who signed is who they claim to be and signed voluntarily, which matters if the note ends up in court. A witness at signing, or two depending on your state, serves a similar purpose at no cost.
Electronic signatures work too. The federal Electronic Signatures in Global and National Commerce Act (ESIGN Act) provides that a contract cannot be denied legal effect solely because it was signed electronically.9Office of the Law Revision Counsel. 15 USC Ch. 96 – Electronic Signatures in Global and National Commerce Both parties must affirmatively consent to electronic delivery and be informed of their right to receive paper copies.10National Credit Union Administration. Electronic Signatures in Global and National Commerce Act – E-Sign Act Platforms like DocuSign and HelloSign handle those consent requirements automatically.
Keeping the Note and Enforcing It Later
The lender should store the original signed note somewhere secure, such as a fireproof safe or a bank deposit box. Both parties should keep a fully signed copy. Digital scans are useful backups, but courts often require the original when enforcing a note, so don’t rely on a PDF by itself.
If the borrower stops paying and informal collection fails, the note gives the lender a clear path to enforcement. Small claims court is usually the cheapest option for smaller loans, with jurisdictional limits between $2,500 and $25,000 depending on the state. Larger amounts have to be filed in a higher court, where attorney fees and court costs climb quickly. This is why the attorney fees clause matters: without it, winning in court can still cost more than the note was worth.