Personal Loan Agreement / Promissory Note — United States

Overview

A personal loan agreement (often paired with, or taking the form of, a promissory note) documents a loan of money between individuals — commonly family members or friends — setting out the amount, interest rate, and repayment terms. Loans between individuals in the United States are governed by ordinary state contract law, but two areas of law specific to lending require particular attention: state usury statutes, and the IRS's imputed-interest rules for below-market loans. Usury limits: every state caps the interest rate that may be charged on certain loans (the specific cap, and which categories of loan it applies to, varies significantly by state — some states set a low default cap that only rises with a written agreement specifying a higher rate up to a statutory ceiling, others have different caps depending on loan size or purpose). Charging interest above the applicable state cap can render the interest provision unenforceable, and in some states can expose the lender to penalties or forfeiture of the principal. The governing state and its usury limit must be checked before setting the interest rate in this agreement. IRS imputed interest and the Applicable Federal Rate (AFR): the IRS treats a loan between individuals — most commonly a family loan — that charges no interest, or interest below the IRS's published Applicable Federal Rate for the loan's term, as potentially triggering "imputed interest": the IRS may treat the lender as having received interest income at the AFR even though it collected less (or nothing), and may treat the foregone interest as a taxable gift from lender to borrower if it exceeds the annual gift tax exclusion. There are de minimis exceptions (notably for loans of $10,000 or less between individuals, and special rules for loans up to $100,000 tied to the borrower's net investment income), but for any loan of meaningful size, pricing the loan at or above the relevant AFR, or documenting the below-market rate deliberately with awareness of the gift-tax consequence, is the standard way to avoid an unexpected imputed-interest problem — this is a numeric, published-rate area where the parties (or their accountant) should check the current AFR for the loan's term at the time it is made. When to use it: for a loan between individuals — family, friends, or informal business associates — where the parties want a clear written record of the amount, interest, and repayment terms rather than relying on an informal understanding, which is a common source of family disputes and is also generally required by the IRS to substantiate that a family transfer was a genuine loan rather than a disguised gift. Key clauses: principal amount, interest rate (checked against the state usury cap and, if family/related-party, against the IRS AFR), repayment schedule (lump sum, installments, or on-demand), default and late-payment consequences, and, if the loan is to be secured, a description of any collateral (which for a meaningful secured personal loan typically requires a separate security agreement and, for real property, a mortgage or deed of trust recorded with the relevant county). Common pitfalls: setting an interest rate above the governing state's usury cap; treating a substantial, no-interest family loan as though it has no tax consequences, when it may trigger imputed interest and gift-tax exposure; and failing to document the loan in writing at all, which both invites disputes and can cause the IRS to recharacterize the transfer as a gift.

Information to customize

• Lender's name

• Lender's address

• Borrower's name

• Borrower's address

• Governing state

  Usury interest-rate caps vary significantly by state and must be checked before setting the interest rate.

• Principal amount of the loan

• Annual interest rate

  Must not exceed the governing state's usury cap. For loans between related individuals, compare against the IRS Applicable Federal Rate to avoid imputed interest.

• Date the loan is made

• Repayment structure

  Lump sum, installments, or on-demand.

• Repayment schedule details

• Collateral securing the loan (if any)

• Late payment / default consequences

• Date of signature

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Frequently asked questions

Is there a maximum interest rate I can charge on a personal loan?

Yes. Every state has a usury statute capping the interest rate that can be charged, and the specific cap varies significantly by state and sometimes by loan type or size. Charging interest above the cap can make the interest provision unenforceable and, in some states, expose the lender to penalties.

What is imputed interest and why does it matter for a family loan?

If a loan between individuals (commonly family) charges no interest or interest below the IRS's published Applicable Federal Rate, the IRS can treat the lender as having received interest income at the AFR anyway, and can treat the foregone interest as a taxable gift if it exceeds the annual gift exclusion. There are de minimis exceptions for smaller loans, but larger interest-free family loans should be reviewed with a tax advisor.

Does this loan need to be secured by collateral?

No, a personal loan can be unsecured. If the parties want collateral, a separate security agreement (and, for real property, a recorded mortgage or deed of trust) is typically needed to make the security interest enforceable against third parties.

What happens if the borrower doesn't repay on time?

The consequences — late fees, default interest, or acceleration of the full balance — should be spelled out in the agreement's late-payment and default clause, since there is no automatic statutory remedy beyond what state contract law generally provides.

Should a loan between family members be documented in writing?

Yes. A written agreement helps prevent disputes and is generally needed to substantiate to the IRS that a family transfer was a genuine loan rather than a disguised gift, which matters for both imputed-interest and gift-tax purposes.

Does this agreement need to be reviewed by an attorney or tax advisor?

It's advisable, particularly to confirm the interest rate complies with the governing state's usury cap and, for larger family loans, to assess the IRS imputed-interest and gift-tax implications.

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