An unsecured loan agreement is a written, two-sided contract in which one person lends money to another with no collateral backing the debt, relying only on the borrower’s promise to repay. Because nothing can be repossessed if the borrower stops paying, the document itself is the lender’s protection. A workable agreement names both parties, states the principal, sets a lawful interest rate, lays out a specific repayment schedule, and includes default, acceleration, late-fee, governing-law, and signature provisions that will hold up in court.
Loan Agreement or Promissory Note
People use the two terms interchangeably, but they aren’t the same thing. A promissory note is a one-sided promise: the borrower commits to repay, and the lender takes on no binding obligation. A loan agreement binds both sides: the lender commits to funding the loan, the borrower commits to repaying it, and the document typically covers more ground, including governing law, dispute resolution, late fees, prepayment, and what happens in bankruptcy. For private loans above a few thousand dollars, the fuller agreement is worth the extra effort.
The Parties and the Principal
Start with full legal names and current addresses for both the lender and the borrower. Nicknames and outdated addresses create real problems if you ever need to serve legal papers. State the principal as an exact figure in both numerals and words, for example, “$15,000 (fifteen thousand dollars).” That number anchors every interest calculation and sets the borrower’s total liability.
Co-Signers and Guarantors
If the borrower’s credit is thin, a third party can back the loan, but the two roles aren’t equivalent. A co-signer shares the debt from day one; the lender can pursue them the moment a payment is missed, and the debt appears on their credit report. A guarantor is only liable after the borrower fully defaults, and the lender must exhaust remedies against the borrower first. Whichever structure you use, the agreement should name the role, state what triggers liability, and say whether the third party must be notified before the lender acts. Vague guarantee language invites litigation.
Interest Rate and Usury Limits
State the rate and how it’s calculated. Simple interest applies only to the original principal; a $10,000 loan at 6% simple interest produces $600 a year regardless of the balance. Compound interest folds unpaid interest back into the principal, so you pay interest on interest. If you compound, the agreement needs to say how often: monthly, quarterly, or annually.
Every state caps the interest a lender can charge. These usury limits vary widely, and exceeding them can forfeit all interest, void the whole agreement, or trigger civil penalties. Check the usury statute in the borrower’s state before setting a rate. When the parties sit in different states, the governing law clause will decide which cap applies.
The AFR and Below-Market Loans
If you’re lending to a friend or family member, the IRS cares about the rate you charge. Under Section 7872 of the Internal Revenue Code, a loan charging less than the Applicable Federal Rate is treated as a below-market loan: the IRS pretends you charged the AFR and gifted the difference back to the borrower, creating phantom taxable income for you and a possible gift tax issue.1Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates
As of mid-2026, the AFR is 3.85% for short-term loans of three years or less, 4.13% for mid-term loans of three to nine years, and 4.87% for long-term loans over nine years.2Internal Revenue Service. Rev. Rul. 2026-11 – Applicable Federal Rates Charging at least the AFR for the loan term avoids imputed interest entirely.
Two exceptions help. Loans of $10,000 or less between individuals are fully exempt from the below-market rules, provided the borrower isn’t using the money to buy income-producing assets like stocks or rental property.1Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates For loans between $10,001 and $100,000, the imputed interest income is capped at the borrower’s actual net investment income for the year, dropping to zero if they had none.
Repayment Schedule
Borrowers reference this section the most, so make it specific. State the payment frequency (monthly, quarterly, or otherwise), the exact calendar date and dollar amount of each installment, and the total number of payments needed to reach a zero balance. If each payment combines principal and interest, consider attaching an amortization table. For a balloon structure, say so plainly: periodic interest payments and a lump-sum repayment of principal on a stated maturity date. Language like “borrower will repay when able” is close to unenforceable.
Late Fees and Prepayment
A late fee should reflect the lender’s actual administrative cost rather than function as a penalty, which may be struck down. State the fee amount and the grace period (commonly five to fifteen days after the due date) before it applies. Many states also cap late fees on consumer loans at a flat amount or small percentage of the overdue installment.
Prepayment deserves its own line. Some agreements allow the borrower to pay off the balance early at no cost; others charge a prepayment fee, often a percentage of the remaining balance or a set number of months of interest, to compensate the lender for lost interest income. If the agreement is silent, most states let the borrower prepay without penalty, but “most states” is not “your state.” Write it down either way.
Default, Notice, and Acceleration
The default clause defines what counts as a breach. Common triggers include missing a payment by a set number of days, filing for bankruptcy, making a false statement on the loan application, or letting a co-signer’s guarantee lapse. Spell them out. A lender suing to collect will have to point to a specific contractual provision the borrower violated, and “failure to perform” won’t carry the weight.
The acceleration clause lets the lender demand the entire remaining balance, principal plus accrued interest, as soon as a default occurs. Without it, the lender can only sue for payments as they come due, which turns one dispute into a series of small-dollar lawsuits. Most agreements accelerate only after a cure period, typically 10 to 30 days from written notice, giving the borrower a chance to catch up.
Build in the written notice requirement. Courts sometimes refuse to enforce acceleration when the lender jumped straight to demanding the full balance without giving the borrower a chance to cure. Putting the notice step in the contract protects the lender’s ability to actually use the clause.
Governing Law and Jurisdiction
When the parties live in different states, the governing law clause decides which state’s law controls the agreement, from usury limits to how a judge reads ambiguous language. The parties usually pick the state where the lender resides or where the loan was made. A jurisdiction clause names the court that will hear any lawsuit, keeping neither party from being dragged across the country. Both clauses reduce litigation costs and make outcomes more predictable.
Signing the Agreement
The contract isn’t enforceable until both parties (and any co-signer or guarantor) sign and date it. The signing date fixes when the loan begins, when interest starts accruing, and when the repayment clock starts.
Electronic Signatures
The parties don’t need to be in the same room. Under the federal Electronic Signatures in Global and National Commerce Act, a contract can’t be denied legal effect because it was signed electronically.3Office of the Law Revision Counsel. 15 USC 7001 – General Rule of Validity Platforms like DocuSign or HelloSign satisfy this, and most states have adopted the Uniform Electronic Transactions Act, which mirrors the federal rule. Both parties must consent to signing electronically, and the system must retain a record that can be accurately reproduced.
Notarization and Storage
Notarization isn’t legally required for most unsecured loan agreements, but it adds real protection on larger amounts. A notary verifies each signer’s identity against a government ID, making a later forgery claim much harder to sustain. Once signed, both parties should keep an original or a complete electronic copy with embedded signatures, stored somewhere secure: a fireproof safe, a safe deposit box, or an encrypted digital service. A lost original can complicate collection years down the road.
Tax Reporting the Lender Can’t Skip
Interest you receive is taxable, even on a casual loan to a relative. If you collect $10 or more in interest from a single borrower in a calendar year, file Form 1099-INT: one copy to the borrower, one to the IRS.4Office of the Law Revision Counsel. 26 USC 6049 – Returns Regarding Payments of Interest Below that threshold, you still report the interest on your personal return.
For below-market family loans under Section 7872, you report the imputed interest as income even if no cash interest changed hands. Because the forgone interest is treated as a gift to the borrower, it counts against the annual gift tax exclusion, which is $19,000 per recipient in 2026.5Internal Revenue Service. What’s New – Estate and Gift Tax Imputed interest plus any other gifts to that person over the threshold means filing a gift tax return.
When Federal Disclosure Rules Apply
A private individual making a one-off loan to a friend generally isn’t subject to the Truth in Lending Act. Regulation Z defines a “creditor” as someone who extended consumer credit more than 25 times in the preceding calendar year.6Consumer Financial Protection Bureau. Regulation Z – 1026.2 Definitions and Rules of Construction A single personal loan doesn’t come close. If you make lending a regular side activity and cross the 25-loan line, the full APR disclosure and rescission rules kick in; check your count before you assume you’re clear.
Collecting After Default
The agreement doesn’t enforce itself. The lender typically opens with a written demand giving the borrower a last chance to cure, then files a breach-of-contract lawsuit in the court named by the jurisdiction clause or, for smaller amounts, in small claims court.
Watch the clock. Every state sets a statute of limitations on written contracts, usually three to six years from the date of default or the last payment, though some states run longer.7Consumer Financial Protection Bureau. Can Debt Collectors Collect a Debt That’s Several Years Old? Miss the window and you lose the right to sue no matter how well-drafted the contract is. If the borrower goes quiet, don’t sit on it.
If the Borrower Files Bankruptcy
An unsecured lender has no collateral to seize and stands with the general creditors, often recovering little or nothing. In a Chapter 7 case, most unsecured personal loan debt is dischargeable.8United States Courts. Discharge in Bankruptcy
One exception matters. If the borrower obtained the loan through fraud, false pretenses, or a materially false written statement about their finances, the debt may be non-dischargeable under Section 523(a)(2) of the Bankruptcy Code.9Office of the Law Revision Counsel. 11 USC 523 – Exceptions to Discharge That protection isn’t automatic. The lender has to file a separate action in bankruptcy court asking the judge to declare the debt non-dischargeable. If you lent based on financial information the borrower gave you, keep those documents. They become the evidence.8United States Courts. Discharge in Bankruptcy