How to Write a Loan Agreement for Money You Lend to a Friend

You said yes before you finished thinking about it. A friend’s car died, the rent came due, or a small business idea needed a push, and suddenly you were agreeing to help on a handshake. Most of the time that works out. But when a repayment date slips and nobody remembers the exact terms, the awkwardness can cost more than the money. A written loan agreement between friends turns a fuzzy favor into a clear plan both people can follow.

This guide covers what to include, how interest and taxes come into play, and how to put the document together step by step. It’s educational content, not legal or tax advice, and rules vary by state.

Why a Loan Agreement Between Friends Matters

Friends rarely see themselves as lender and borrower, and that’s exactly the problem. Without a record, each person remembers the deal a little differently. Was it $1,500 or $2,000? Was repayment due in three months, or “whenever things get better”?

A loan agreement between friends fixes this by putting the amount, the timeline, and the consequences in writing. It also lowers the emotional temperature. When a payment is late, you’re pointing to a shared document instead of arguing over who promised what.

There’s a tax reason too. If an undocumented transfer ever gets questioned, the IRS may say the family loan was a gift and disallow a bad debt deduction. That matters if the money never comes back. portebrown

Decide First: Is This a Loan or a Gift?

Before you draft a loan agreement between friends, ask a blunt question: could you live with never seeing this money again? If the answer is no, consider lending a smaller amount, or giving a smaller sum outright. One sensible test is to lend only what you could stomach losing. Giving yourself a day to think, much like the 24-hour rule for spending, keeps guilt from making the decision for you.

If you choose to gift the money, gifts have their own rules. The annual gift tax exclusion is $19,000 per recipient for 2026, and the IRS gift tax FAQ explains that the donor is generally responsible for paying any gift tax. spencerfane irs

It’s also worth asking why your friend is coming to you. If a bank said no, understanding why a loan application gets rejected can reveal repayment risks you’d want to know about. And if the need is urgent, reviewing when emergency personal loans make sense may point to an option that protects both your savings and the friendship.

What to Include in a Written Loan Agreement

A solid loan agreement between friends is specific, short, and a little boring. Many people call a simple version a promissory note, which is a signed promise to repay. Include these items:

Names and addresses: the full legal names and addresses of both people.
Loan amount and date: the exact dollar amount, the date, and how the money is delivered. A bank transfer is easy to trace.
Interest rate: a stated rate, or a clear statement that no interest is charged.
Repayment schedule: the payment amount, due dates, payment method, and final due date.
Late payments: any grace period and late fee, if you want one. Keep it modest.
Early repayment: confirmation that the borrower can pay off the balance early without a penalty.
Default terms: what counts as default (for example, two missed payments in a row) and what happens next, including whether the full balance becomes due.
Collateral: whether the loan is secured by property or unsecured.
Signatures: both people sign and date it, and each keeps a copy. A witness or notary isn’t always required, but check your state’s rules.
Governing law: which state’s law applies.

Add one more line saying any changes must be in writing and signed by both people. That single sentence prevents many “but we agreed verbally” disputes later.

Interest, Taxes, and the $10,000 Rule

Interest is the part of a loan agreement between friends that people most often skip. Many treat it as optional, and in a personal sense it is. For tax purposes, though, it can matter. The IRS has below-market loan rules meant to stop large taxable gifts from being disguised as interest-free loans. The IRS publishes Applicable Federal Rates (AFRs) every month, and a loan made below the AFR can trigger what’s called imputed interest. In plain terms, the lender may owe tax on interest they never actually collected. turbotax

The good news is that gift loans of less than $10,000 are exempt, as long as the money isn’t used to buy income-producing assets. The threshold generally looks at the total of all loans between you and that borrower, so a second loan later can push you over it. Above $10,000, charging at least the AFR is the usual way to stay clear of imputed interest, and a few narrower exceptions exist for loans up to $100,000. That’s where a tax professional is worth the fee. turbotax

If you do charge interest, don’t pick a number at random. Compare it with what commercial lenders charge by reviewing personal loan interest rates in 2026. Many states also cap the interest that can legally be charged, so a very high rate may not be enforceable. When you build a loan agreement between friends, the interest line deserves ten minutes of research.

Step-by-Step: Writing Your Loan Contract

Here’s a simple process for drafting a loan agreement between friends without needing a law degree.

Talk it through first. Agree on the amount, the timeline, and what you’ll both do if life gets in the way. It’s far easier to discuss this before the money moves.
Pick the interest. Zero, the AFR, or something in between, keeping the tax notes above in mind.
Build the repayment schedule. A personal loan EMI calculator can split the balance into equal monthly payments so both of you see the same numbers.
Write in plain language. A simple illustration of the core sentence might read: “On [date], [Lender] lends [Borrower] $[amount]. [Borrower] promises to repay this loan in [number] monthly payments of $[amount], beginning [date], with interest at [rate]% per year. Any change to this agreement must be in writing and signed by both parties.” Treat this as an example of tone, not as a legal template.
Sign and share copies. Both people sign and date the contract. Each keeps a copy, and a photo or PDF stored somewhere safe is a good backup.
Send the money in a traceable way. Use a bank transfer or check, not an unrecorded cash handoff.
Track every payment. Keep a running record and send a quick confirmation after each payment. Setting up automatic transfers helps the borrower pay on time and keeps the schedule from depending on anyone’s memory.

A Hypothetical Example

Imagine Jordan lends a friend, Maya, $12,000 to cover moving costs and a security deposit. They agree on 24 months of repayment at 4% annual interest. That rate is invented for illustration. Because the amount is above $10,000, Jordan would first check the current AFR and think about the tax treatment of the interest.

At those terms, a standard amortization calculation puts Maya’s payment at roughly $521 a month, with total interest of about $505 over the two years. They sign two copies, Jordan sends the money by bank transfer, and Maya sets up an automatic payment for the first of each month.

In month ten, Maya’s work hours get cut. Because the terms are on paper, the two can talk calmly about a temporary lower payment and record it in a signed amendment. That’s how a loan agreement between friends works in real life. It isn’t a threat, just a map both people can read.

Common Mistakes With a Loan Agreement Between Friends

Even well-meaning lenders trip over the same few issues:

Relying on texts or memory. A signed document is stronger and clearer than scattered messages.
Vague due dates. “When I get paid” isn’t a date. Pick specific ones.
Leaving out consequences. A loan agreement between friends that never explains what happens after a missed payment leaves everyone guessing.
Ignoring the tax side. Loans above $10,000 deserve a look at the AFR and imputed interest rules.
Adding loans without updating the paper. Each new loan changes the total and may change the tax picture.
Lending money you need. If the loan would strain your own budget, a smaller amount or a gift may be wiser.
Letting missed payments slide in silence. Small delays grow into big resentments. Address them early and kindly.

What If Your Friend Can’t Repay?

Even a carefully drafted loan agreement between friends can’t predict every bump. If your friend falls behind, talk early. Options include a temporary lower payment, a longer term, or a short pause, all recorded in a signed written amendment. If your friend is juggling several debts, learning the difference between debt settlement and debt consolidation may help them find a workable path.

If the debt truly can’t be collected, the IRS has specific rules. According to IRS Topic 453 on bad debts, a nonbusiness bad debt must be totally worthless to be deductible, and it’s reported as a short-term capital loss with a detailed statement attached to the return. A signed loan contract and a record of your collection efforts can make that claim far easier to support. Small claims court is sometimes an option, but it costs time and often the friendship, so most people treat it as a last resort. Limits vary by state. irs

Practical Takeaways

Decide whether the money is a loan or a gift before you hand anything over.
Put every loan agreement between friends in writing, with names, amount, dates, and signatures.
State the interest rate clearly, even if it’s zero.
Check the $10,000 threshold and the current AFR if you’re lending more.
Create a specific repayment schedule and use traceable payment methods.
Record changes in writing, signed by both people.
Keep copies of the agreement, the transfer, and every payment.
For large amounts, consider asking an attorney or tax professional to review the document.

Final Thoughts on a Loan Agreement Between Friends

Lending to a friend is an act of trust, and a loan agreement between friends is how you protect that trust. The document doesn’t signal suspicion. It shows that you respect the friendship enough to be clear about it. Spend a little time on the terms, think through the tax basics, and only lend what you can afford to lose.

This article is for educational purposes only and isn’t legal, tax, or financial advice. Laws and tax rules vary by state and change over time, so consider consulting a licensed professional about your situation.