Loaning money to family members and friends can be a delicate subject. Always protect yourself by putting the terms of the loan or interest rates in writing. “Promissory notes” are documents that contain the terms of a loan so that there is a legally actionable record of the loan specifics.
Whether for help with a down payment, credit card debt or family loans, any loan agreement can have legal, financial or tax implications. If your friends and family take offense at the suggestion that you create a promissory note, an easy way to justify it is to explain that the loans can have tax consequences and you simply need a written record in case the IRS ever audits you.
The Basic Terms of Promissory Notes
There are really only three very basic things that need to be in promissory notes, and keeping it simple can help alleviate any fears that friends or family may have about signing the note. The three things to include in promissory notes are:
- The amount of money in the loan (for tax purposes)
- How and when the loan will be repaid (such as a repayment schedule)
- Whether, and how much, you will charge for interest or interest payments
Optionally, you may also choose to secure the loan with property (for example, you could use a friend’s car as collateral). This makes the agreement more complex, but if you do choose to secure the loan with property here are some guidelines:
- Personal property: Personal property comes in two flavors, tangible and intangible. Tangible personal property is essentially someone’s “stuff”, such as a car, a computer or a piece of jewelry. In addition to the promissory note, you need to create a security agreement establishing the parties’ respective rights to the piece of property. Intangible personal property includes things such as patents, copyrights, trademarks as well as ownership rights in a business.