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.