Whether you’re the one lending money or you’re borrowing it, loans between friends and family offer many benefits. However, it’s important to keep everyone protected, which is why you might need to consider setting up a loan agreement.
What Is A Loan Agreement?
Just like the kind of agreement you’d make formally with a bank when getting a loan, a loan agreement is a legally binding document that protects the borrower and the lender. These agreements stipulate and enforce the agreements that both parties make and outline any clauses and conditions surrounding the loan.
Loan agreements can vary greatly, but for the basic format, you can check out this free pdf loan agreement to help you draft your own.
Benefits To Loan Agreements Between Friends and Family
By borrowing money from a friend or a family member, you can avoid getting a bank loan. There are many benefits that come from this, the main one being either reduced or no interest on the money you pay back. Furthermore, someone close to you is unlikely to ask for your credit score or to ask you to provide other documents which a bank may use to refuse your loan request.
As they’re your friends or family, they’ll also likely be much more lenient with repayments and likely won’t ask for collateral if you’re unable to adhere to certain pre-set repayment dates. On the other hand, if you’re the one lending money, you can bestow these benefits to a loved one, setting them up for greater financial success.
Why Should I Set Up A Loan Agreement?
When borrowing or lending money between close friends and family members, it can seem easier to conduct the transactions without any legal paperwork. However, loan agreements ensure that the lender is financially protected, with a legally binding promise in place to ensure that they’ll receive repayments on the money they lent out.
Having official paperwork detailing your loan will also protect you from any additional taxation or investigation from the IRS for the money you received. Creating a paper trail for all of your financial transactions is incredibly important and may prevent you from facing any civil or criminal charges.
What Should I Include In My Loan Agreement?
Whether setting up a loan agreement between you and a bank or between family or friends, there are some key things you must include. Keep in mind that all of this information should be clear and concise so that anyone reading the agreement can fully understand it without any misinterpretation.
The Principal Sum
In layman’s terms, this is the amount of money borrowed. It might be given in installments or as a singular payment, but all of the money agreed to be transferred from one party to the other must be noted clearly.
It should be specified when the money is to be paid back and by what date. Often, repayments will be done in installments, paid every month, quarter, or year until the sum is repaid in full or until the lender is satisfied. Rather than set amounts, repayments might stipulate that a percentage of the borrower’s income is paid instead.
When family or friends agree to borrow or lend money, they may not charge as much interest as a bank would, or any at all. However, if the borrower and the lender agree that some interest will be paid, it should be specified how much and how that impacts repayment installments. This interest can be calculated.
If specific dates are given in which the borrower must pay a certain amount of money, then any consequences for these late payments should be detailed in full within the loan agreement and agreed to by both parties.
Failure To Pay
Similarly to late payments, any consequences for the borrower failing to repay the full or specified amount must be included in detail. This may include the forfeiting of collateral assets or may result in legal action, depending on the agreement.
In order to be legally binding, a loan agreement requires both the lender and the borrower to sign the contract and will ideally have at least one neutral witness who should also sign the contract, though this last part is not a legal requirement.
What Additional Clauses Should I Consider?
People are much more forgiving when dealing with family and friends, so you might want to include some additional clauses in your loan agreements with them. Certain clauses may allow the lender to default without repercussion within certain parameters, such as losing their job or becoming too unwell or injured to work.
There are many other clauses that you could implement, either to protect the lender or the borrower, that may additionally protect the relationship between the two parties.