Negotiating a loan with a friend or family member can be a great alternative to high-interest forms of consumer credit. Formalizing that loan in a personal loan agreement isn’t unfriendly – it’s the best way to keep your loan terms clear and protect your relationship. A well-written personal loan agreement is key to making sure your financial transaction doesn’t lead to conflict.
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Why Choose a Personal Loan?
Working out a personal loan can have advantages for both parties. Borrowers get the funds they need and avoid risky loans from payday and installment lenders. Lenders get the satisfaction of helping a friend or relative – plus regular interest payments. In today’s low-interest rate environment, even a low-interest personal loan may provide better returns than a CD or bond.
Our advice? Don’t borrow more than you need and can afford to pay back. If you’re the lender, don’t lend more than you can afford to lose, particularly if there is no collateral you can seize and the lender is not someone you’d be willing to sue. You don’t want the personal loan to come between you and the other party. Personal loan agreements help keep messiness and uncertainty out of your financial transaction.
You don’t have to be a lawyer to write a personal loan agreement. However, depending on the level of complication involved in the loan, you may want to hire a lawyer to help you with the details of the loan agreement. If you want to take the DIY approach, here are some basics to include in your document:
Basic Loan Terms
A loan agreement needs to be clear about certain basics. Who are the parties to the loan agreement? How much is being borrowed? What is the interest rate? What is the length of the loan term and when will payments be expected? These are the backbone of your personal loan agreement.
If you’re the borrower in the agreement you want a low interest rate that will leave you with payments you can afford. You want to have money left over to maintain your lifestyle and save for retirement. If you’re the lender, you want an interest rate that will at least let you beat inflation, and you want clarity as to how and when you’ll receive payments.
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After you’ve covered the basic loan terms in your personal loan agreement you’ll want to address some contingencies. What happens if the borrower can’t keep up with payments? Is there collateral that the lender can seize? Are there late fees? Is it possible to negotiate a lower interest rate or payment plan in case of hardship? Are there prepayment penalties if the borrower wants to pay off the loan more quickly? It’s important to work together to figure out the answers to these questions. Get them in writing and make sure everyone is clear on the specifics.
Related Article: 5 Tips for Lending Money to Friends or Family
Automation is Your Friend
Once you’ve hammered out the details of your loan agreement and you’ve got it signed and dated, it can be a good idea to set up automatic payments. That way, if you’re the borrower you won’t forget to make your payments. If you’re the lender, automatic payments from the borrower mean you won’t find yourself in the awkward position of having to remind your friend or relative to fork over the money you’re owed. Automatic payments let the loan proceed seamlessly. No need to ask for a check over Sunday dinner.
Think you can seal a loan agreement with a simple handshake? You’re probably better off formalizing your financial transaction by crafting a personal loan agreement. Make sure you cover the basics of the loan agreement and include provisions for some worst-case scenarios. Once both parties have signed the agreement you can focus on your relationship and not worry about the loan.
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