How to Create a Loan Agreement

Creating a loan agreement is not particularly difficult, but it's important to ensure that the terms and language expressed in the agreement are ironclad--this way you'll be protected if the loan defaults. There are several items that must be included on a loan agreement.

How to Create a Loan Agreement

Determine the terms of the loan you are extending. You will need a loan agreement if you are making a loan to a friend or relative--these are called private loans. Make sure both you and the borrower have agreed to the terms, which include the loan amount, the interest rate, the term (length) of the loan, and the consequences of default.

Hire an attorney to oversee the language in the loan agreement. This is essential because the document (which is a legal document, notarized by a notary public) has to be able to hold up in court. The best way to find an attorney for this process is to ask your local banker what attorneys she uses for loan closings. Be prepared to pay a fee for the attorney's services.

Write the opening section so that it clearly demarcates the BORROWER and the LENDER, and the date on which both parties are agreeing to the loan. Next, write the promissory note. This section includes the loan amount, the interest rate, the due date, the term, and the grace period (if any). A grace period is a length of time after the payment due date when the borrower is still considered "on-time."

Write additional loan terms. These include how the borrower makes payments, a demand clause (a letter from the lender requiring full payment) if you want extra security, definition of default and the consequences of such an action, late-payment fee disclosures, rate adjustment disclosures, indemnification clauses, and any other restrictions on the loan that you deem necessary. Essentially, the additional terms further protect the debt against default by legally binding the borrower to the agreement.

Have the borrower read the document. When closing the loan, bring the check and five copies of the loan agreement. The best closing will have the following participants: you, your attorney, the borrower, his or her attorney, and a notary public to legitimize the document. Once all parties are satisfied by the terms, the lender, borrower and notary public must sign the document, thus making it a legally binding loan agreement.


About the Author

Based in Eugene, Ore., Duncan Jenkins has been writing finance-related articles since 2008. His specialties include personal finance advice, mortgage/equity loans and credit management. Jenkins obtained his bachelor's degree in English from Clark University.