Loans To Friends And Family: What You Need To Know About Promissory Notes

Law Blog

Negotiating loans between friends and family members can be somewhat delicate situations. If you're on the lending side of this type of agreement, you should consider drafting a promissory note as part of the process. While you might only think of promissory notes as part of a loan with a bank or other formal lender, the truth is that promissory notes are important for any kind of loan, because they provide you with the legal details you need to collect on the balance. Here's a look at what you need to know about using a promissory note to validate the loan you provide your loved one.

What Do You Include In A Promissory Note?

A promissory note is a simple, straight-forward document with only a few required details. In fact, the more basic you can keep it, the easier it might be for everyone involved. Here are the key details you need to provide:

How much is the loan for? Clearly detail exactly how much you're loaning. You can even specify how the money was supplied, either in cash, a check or a money order.

What kind of collateral is securing the loan? If your loved one has offered you any kind of security for the loan, it's in your best interest to list that as well. For example, your friend may give you a valuable collection or prized item as a way to guarantee payment on the loan.

How is the loan going to be repaid? Whatever the payment agreement might be, detail it clearly in the promissory note. You might expect to have a lump sum payment due to you by a certain date, or you may have negotiated installments so that he or she can pay you back over time. If you have a lump sum agreement, list the due date. If it's an agreement for installments, illustrate the installment schedule.

What kind of interest applies to the loan? You might be tempted to loan the money without interest, but if you do that, the Internal Revenue Service is going to view the money as a gift, not a loan. You can charge a small amount of interest, even one or two percent. In fact, if you don't, the Internal Revenue Service may actually impute interest on the loan for you, even if you didn't charge it. You'll have to claim the amount determined on your taxes as income.

What If The Borrower Hesitates To Sign?

Your friend or family member may hesitate to sign a promissory note, because it makes "borrowing money from family" into a formal loan. If he or she is uncomfortable with the idea, simply explain that you're doing so to protect both of you in the event of a tax audit.

Loaning money to family and friends may seem like no big deal, but when you're lending large sums of money, it becomes more serious. With these tips, you can create a promissory note that will help you enforce the loan and protect your taxes. For more tips, talk with a securities attorney like those at Carter & West Law.



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