Lending money to friends and family: put it in a promissory note

Why write it down

Loans between people who know each other often go wrong because each side remembers the deal differently. A promissory note replaces memory with a clear record of the amount, the repayment plan and what happens if payments stop.

It also keeps the relationship healthier. A clear plan makes it easier to ask about a late payment without it feeling personal.

What a promissory note includes

• The names of the lender and the borrower.
• The amount borrowed and the date.
• The interest rate, or a statement that the loan has no interest.
• The repayment plan: regular installments with dates, or one lump sum on a due date.
• Whether the borrower can repay early without a penalty.
• What counts as a default, and what happens then, such as a late fee or the full balance becoming due.
• Whether the loan is secured by collateral, for example a vehicle.
• Signatures and the date.

Interest and tax points

States set limits on the interest rate a lender can charge, often called usury limits, and the limits vary. A rate above the limit can make the interest unenforceable.

Federal tax rules can also apply. If you lend a larger amount at little or no interest, the IRS may treat part of the benefit as a gift or as interest for tax purposes. The IRS publishes minimum interest rates, called applicable federal rates, that are used for this.

Tax treatment depends on the amount and the facts. For a large loan, ask a tax professional before you lend.

Loan or gift

Be clear about which one it is. If you mean it as a gift, say so in writing and do not expect repayment. Larger gifts can need a gift tax return even when no tax is due. If you mean it as a loan, the note shows that.

Keeping track

• Keep a signed copy each.
• Record every payment with its date and amount, and give receipts.
• If a payment is missed, raise it early and in writing.
• Keep the note after the loan is paid, and mark it paid in full.