From a technical legal perspective, a private lending transaction does not necessarily require any written documentation. A verbal agreement to loan money is generally enforceable in every state in the United States. However, as a practical matter, it is wise to use a few basic legal documents in any lending transaction to ensure that the terms are clear and the obligations of each party are set forth in writing.
A basic loan agreement that contains the written provisions of the loan transaction is always a good idea. The loan agreement will identify the other documents involved in the transaction, and will set forth all of the rights and obligations of each party. The loan agreement is more general in terms and may be executed before the parties enter into the remaining documents. The loan agreement is the foundational document for a lending transaction.
A promissory note is a short and simple document that imposes a repayment obligation on the person who is borrowing the money. Basically, the borrower promises to repay the money at a certain point in time, with a certain amount of interest, and according to an agreed upon repayment schedule. The promissory note essentially implements the repayment obligation generally referenced in the loan agreement.
From a lender's perspective, it is always best to implement a security agreement as a part of the loan transaction. The security agreement identifies property, called collateral, of the borrower that can be sold or repossessed by the lender in the event that the borrower is unable or unwilling to repay the loan money pursuant to the terms of the promissory note. In the real estate context, a security agreement is referred to as a mortgage or a deed of trust. Breach of the promissory note triggers the lender's rights under the security agreement to go after and take possession of the collateral.
A final document that a lender may want to require as part of a private lending transaction is a personal guarantee. A personal guarantee imposes a repayment obligation on somebody other than the principal borrower under the promissory note. For example, if the borrower under the promissory note is a business entity, the lender may require a personal guarantee from the individual owner of that business entity. Or, the lender may require a personal guarantee from a co-borrower, which is another individual who is different from the individual who signed the promissory note.
- "Nolo's Encyclopedia of Everyday Law"; Shae Irving; 2009
- "Real Estate Finance Law"; Grant S. Nelson and Dale A. Whitman; 2008
- PhotoObjects.net/PhotoObjects.net/Getty Images