Anyone can run into a financial crunch from time to time and need a loan to bridge the cash-flow gap. Even if the person who needs the loan is a close friend, you should always draft a loan agreement to protect yourself from problems in the future. If the friendship sours before you collect, the loan agreement serves as the legal proof you need that the money you provided was not a gift and your friend intended to repay the funds. Without a loan agreement, people can find themselves on the short end of the collection stick.
Construct the first sentence to identify yourself as the lender and your friend as the borrower. Include the amount of money you are lending and the date the loan was made. For example, “John Smith made a loan to Sally Fields on May 5, 2010, in the amount of $1,200.”
Write the interest rate for the loan into the document and the method you will use to compute interest due on the loan. If you do not intend to charge interest on the loan, make that clear in the loan agreement.
Spell out the repayment terms of the loan in detail. If your friend will repay the loan in lump sum after a financial event occurs, such as a tax refund or lawsuit settlement, make sure you include specifics on the inciting event that will trigger the loan as due. If your friend will make payments, provide a detailed description of the payment plan, including the date payments will begin, the amount of the payment due on each pay date and the date of the final payment.
Sign and date the document, along with your friend and a third-party witness. If possible, the third-party witness should be someone who does not have a close relationship to either party of the loan. For example, an employee at your financial institution is a good choice for a third-party witness as he has no vested interest in the loan or the loan collection. You can also have the document notarized by a notary public to serve as a third-party witness to the document.
Never lend money to a friend if you suspect that person will never repay you. If you wish to remain friends and want to help, consider gifting the money rather than loaning it, assuming you can afford to do so. If a loan to a friend goes unpaid, it can be the unspoken issue that eventually makes it too uncomfortable to remain friends.
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