Why You Need a Personal Loan Agreement Between Family Members or Friends

Borrowing money from family or friends can be a terrific alternative to traditional loans, offering lower rates and more flexible terms. To protect both parties and avoid misunderstandings, it’s essential to create a personal loan agreement that outlines the loan terms, interest rate, and repayment plan.

What does a personal loan agreement between family look like?

Borrowed money from a family member can help you avoid a payday loan or another high-interest option. It can be issued just like a traditional personal loan in a lump sum. Once you receive the funds, you can repay what’s owed according to an agreed-upon schedule.

When creating a personal loan agreement, you should discuss these components:

1. Interest rates
2. Repayment terms
3. Consequences of defaulting

Whether you’re charged interest on the loan is up to the family member. They could decide to charge no interest on the loan. However, if they loan you over $10,000, they must set a minimum rate based on the IRS’ applicable federal rates guidelines.

You could use a personal loan calculator to create a repayment schedule. For example, say the family member agrees to loan you $2,000 at 5% interest over four years. Here’s what the repayment schedule could look like:

Monthly payment	Total interest	Total cost
$46	$211	$2,211

Once you decide on the loan terms, you should write the personal loan agreement and have both parties sign their names. Doing so makes the document legally binding. Although this document doesn’t need to be notarized or signed by a witness, it could help add credibility.

If you have trouble repaying the loan, communicate with the family member. They may be willing to modify the loan agreement or pause payments. But remember, if you default on the loan, they could also take you to court.

Sample personal loan agreement between family

You can download a free personal loan agreement form. The agreement should include these elements:

• Loan amount. The agreement should list the original loan amount or principal balance.
• Repayment schedule. Include the date the borrower should make payments and whether they should pay monthly or weekly.
• Interest rate. How much interest is being charged should be stated in the contract
• Late fees. Make sure it’s clear whether the borrower will pay a fee after being late a certain number of days.
• Collateral. If necessary, the agreement should include any collateral—an asset of value, such as a bank statement—the borrower is pledging to secure the loan.
• Borrower and lender signatures. Once you’ve both read and agreed to the terms, sign, and date the loan agreement. Remember to include the signatures of any witnesses.
• Severability clause. This clause ensures that even if one part of the personal loan agreement is unenforceable, the remaining valid sections can still be enforced.
• Date. Write the date the contract goes into effect next to your signatures.
• State. You should also list the state where the contract will be enforced.

If you have any questions about the agreement, discuss them with your family before signing. The document should be clear to both parties to minimize misunderstandings.

What happens in the event of death? Consider naming the lender a beneficiary to the policy.

Michael Menninger

CFP®

Does a personal loan agreement between friends differ from a personal loan contract between family?

A personal loan agreement contains the same elements, whether between friends or family members. However, when a family member is lending you money, they may be more willing to forgive late payments.

Family members might also be more willing to lend to you without a formal contract. But even if they’re willing to do that, we recommend having a personal loan agreement in writing.

Pros and cons of a personal loan agreement between family or friends 

Before borrowing money from a family member or friend, consider the advantages and disadvantages.

Pros

• No credit check

  Unlike a traditional loan, you won’t need to worry about a hard credit check lowering your credit score.

• Potentially cheaper than a traditional loan

  A family member might give you a loan at a much lower rate than a traditional lender.

• Earn interest

  You could earn interest by lending money to a family member or friend.

Cons

• Could cause a rift in your relationship

  If you default on the loan, your relationship with the lender could be ruined.

• Potential for extra tax paperwork

  If a family member offers you an interest-free loan more than the annual gift tax exclusion—$18,000 as of this writing—they must file a federal gift tax return. Although they won’t pay taxes on the overage, the amount will be deducted from their estate tax exclusion when they die.

• Payments aren’t reported to the credit bureaus

  Repaying a family loan doesn’t help you build or establish credit since your family member doesn’t report payments to the three major credit agencies, Equifax, Experian, and TransUnion.

Should I give a personal loan to a family member?

If you are a family member being approached for a loan, only you can decide whether it’s a wise move. The following table includes scenarios where it might—or might not—be the right decision.

Consider loaning money to a family member or friend if …	Reconsider loaning money to a family member or friend if …
✅ You can afford to loan money	❌ Lending them money would jeopardize your financial stability
✅ You have a trustworthy relationship with the borrower	❌ They have a history of not repaying past family or friend loans
✅ They’re willing to sign a written agreement	❌ They refuse to sign a written personal loan agreement

When to consider loaning money to a family member or friend

You can afford to loan money

If your loaning money to the family member wouldn’t put your finances at risk, giving them a loan could make sense.

You have a trustworthy relationship with the borrower

If you’ve loaned money to a family member in the past without any hiccups, they may be likely to repay as promised.

They’re willing to sign a written agreement

We recommend not lending money to anyone unwilling to sign an agreement outlining the terms and conditions of the loan.

When to reconsider loaning money to a family member or friend

Lending them money would jeopardize your financial stability 

Loaning money to a family member isn’t wise if it stops you from achieving your financial goals, such as saving for a home or paying down debt.

They have a history of not repaying past loans

Think twice before lending money to someone with a history of defaulting on loans.

They refuse to sign a written personal loan agreement

We recommend not lending money to anyone unwilling to sign an agreement outlining the terms and conditions of the loan.

Before you lend money to a family member, consider your overall financial situation and theirs. Review your finances to ensure you can afford to lend out money. Ask them to share details of their financial situation, including income, so you can assess their ability to repay the loan.

One of the most common mistakes people make when loaning money to family or friends is not having an agreement in place that defines the terms of the loan.

Michael Menninger

CFP®

Alternatives to a personal loan between family or friends

Weighing the pros and cons of various financial resources is key to making informed decisions. 

Personal loans between family or friends may be appealing due to their flexibility and potential for lower interest rates. Still, one of these alternatives might fit your needs better and lessen potential relational strain.

Traditional personal loans 

Unlike personal loans between loved ones, traditional personal loans are a formal financial contract with an established lender. For those concerned about their credit score, credit unions or online lenders targeting bad-credit borrowers can provide useful alternatives. 

These can feature competitive loan terms and fixed repayment schedules. Of course, your creditworthiness often determines the interest rates, which can be higher than what you’d get from a family member or friend.

Secured personal loans 

Secured personal loans offer a solid alternative for those with assets to pledge as collateral. These can be less risky for lenders, often resulting in more favorable interest rates. However, failure to repay may result in the loss of the asset pledged as collateral.

Savings

Instead of borrowing, consider using your savings. This approach has the advantage of no repayment terms or interest rates. But it could also deplete your emergency fund or savings for other future needs.

Peer-to-peer lending 

Peer-to-peer lending involves borrowing from an individual or group instead of a financial institution. It’s somewhat similar to borrowing from family or friends, but it’s a more formal setup with strict repayment terms and has the benefit of anonymity.

0% or low-interest credit cards 

For those with good credit, 0% or low-interest credit cards can be cheaper than borrowing from family or friends. However, be cautious of high interest rates once the promotional period expires.

Payment plans or financing

Payment plans or financing, particularly for big-ticket items, can sometimes be negotiated with the vendor. These arrangements often come with no interest or low rates for a specific period, making it a potentially inexpensive way to finance a purchase without involving family or friends.

Crowdfunding

Crowdfunding platforms offer nontraditional financing methods for individuals, particularly those with creative projects or facing hardships. But you often need a compelling reason for strangers to contribute to your cause.

Grants or assistance programs

Depending on what the money is for, grants or assistance programs available from government agencies or nonprofit organizations could help meet your financial needs, making this a no-obligation alternative.

Financial counseling 

For financial challenges, professional guidance from a credit counselor might be helpful. They could help in budgeting, financial planning, and sometimes negotiating with creditors for more manageable repayment terms.