How to Loan Money to Someone

Lending money is a good way to help someone in financial distress. You might also make some money in the process. However, you shouldn’t hand over money without protecting yourself. Negotiate the details of the loan and draft appropriate legal documents, such as a promissory note. Hopefully, the borrower will pay back the loan, but be prepared to sue if necessary.

Part 1

Part 1 of 3:

Negotiating the Terms of the Loan

1
Talk with the borrower. Before agreeing to lend money, you should get some sense of what the borrower wants to do with it.^{[1]XExpert SourceJonathan DeYoe, CPWA®, AIF®
Author, Speaker, & CEO of Mindful MoneyExpert Interview. 15 October 2020.}^{[2]XResearch source} Ask them why they don’t go to a bank and get a personal loan. Chances are, the person has poor credit. However, many lenders will give personal loans to people with bad credit.
- You can also assess how likely they are to repay the loan. Are they working? How much do they make in a week? What other debts do they have to pay?^{[3]XResearch source}
2
Choose how much to lend. Don’t simply agree to lend whatever someone asks for. For example, they might want to buy a computer but ask for $3,000. You should definitely follow up and ask what computer they want. It’s not unusual for people to ask to borrow more than they need.
- It’s up to you to decide how much to let someone borrow, but you shouldn’t agree to more than you feel comfortable with. A good rule of thumb: don’t lend more than you can afford to lose.^{[4]XResearch source}
3
Pick a reasonable interest rate. You might want to charge interest, even if you are lending to friends or family.^{[5]XExpert SourceJonathan DeYoe, CPWA®, AIF®
Author, Speaker, & CEO of Mindful MoneyExpert Interview. 15 October 2020.} By paying interest, the borrower shows that they are serious about repaying the loan. Don’t make the interest rate too high, which will make repaying the loan more difficult.
- Your jurisdiction probably has a maximum interest rate you can charge. Research this rate online.^{[6]XResearch source}
- In the U.S., you must charge the minimum interest rate set by the IRS if you make a big loan (e.g., to buy a house).^{[7]XResearch source} You can find the current rate at the IRS website.
4
Set the repayment schedule.^{[8]XResearch source} The repayment schedule will probably depend on the size of the loan. If you lend someone $500, they should be able to pay you back in a few months. However, if you lend someone $5,000, they might need a few years to pay back the loan.
- The longer the repayment period, the less a person will have to pay every month. However, they’ll pay more over the length of the loan if you charge interest.
5
Choose how much will be repaid each month.^{[9]XResearch source} Ideally, the borrower will pay an equal amount each month. This makes it easier for the person to budget and get in the habit of sending you an equal amount every month. If necessary, the very last payment might be a smaller amount.
- Depending on the circumstances, you might have the borrower pay you back every week. For example, the borrower might get paid every week and the amount borrowed might be small. In this situation, expecting repayment every week could make more sense.
You want to prod the borrower to pay back the loan in a timely manner, so you should think about charging a fee if they miss payment.^{[10]XResearch source} For example, you might charge $25 if they are 60 days late with the monthly payment.
7
Consider asking for security. A secured loan is safer than an unsecured one. With a secured loan, the borrower puts up property they own as collateral. If they can’t make repayment, you have a legal right to seize the property and sell it.^{[11]XResearch source} Almost anything a borrower owns can be security—their car, computer, stocks, etc. However, they must own the collateral, not rent it.
- Getting security makes the loan process a little more complicated. For example, you should check to see that the property hasn’t been pledged as collateral for other loans. If it has, then the collateral might not have any value. You’ll search for other security interests at your Secretary of State’s website.
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Part 2

Part 2 of 3:

Making the Loan Legal

1
Find forms and templates. There are sample promissory notes online or in legal books. Use one as a guide when drafting your own. You want a legal contract in case the borrower defaults, so don’t be shy about insisting on a promissory note.^{[12]XExpert SourceJonathan DeYoe, CPWA®, AIF®
Author, Speaker, & CEO of Mindful MoneyExpert Interview. 15 October 2020.}^{[13]XResearch source}
- If the loan is really large—say, $10,000—you should probably hire a lawyer to draft the promissory note for you.
- If you're loaning a small amount to a friend, consider skipping the legal documentation and giving the money without the expectation that you'll get it back.^{[14]XExpert SourceJonathan DeYoe, CPWA®, AIF®
  Author, Speaker, & CEO of Mindful MoneyExpert Interview. 15 October 2020.}
2
Include basic information about the loan. At the top of the document, you should include the title “Promissory Note” and then the following information in the first paragraph:^{[15]XResearch source}
- The amount of the loan.
- The date.
- Your name as the lender.
- The borrower’s name.
3
Include the promise to repay. The borrower must explicitly promise to repay the loan. If this language is missing, you don’t have a legal contract.
- Sample language could read, “For value received, the undersigned (‘Borrower’), hereby promises to pay to [insert your name] (‘Lender’), the principal sum of $4,000 pursuant to the conditions set forth in this document.”^{[16]XResearch source}
4
Explain how the loan will be repaid. State how often payment will be made—monthly, weekly, etc.—and the date the first payment is due. Also identify the interest rate and whether the borrower can prepay the loan without penalty.^{[17]XResearch source}
- Tell the borrower how to pay you—cash, personal check, money order, etc.
5
Identify what happens if the borrower is late. You might want to charge a penalty for late payment, or you could increase the interest rate. Spell out in detail what will happen.
- You also might want to accelerate the loan. For example, if the borrower misses a payment, you can immediately demand that they pay the entire loan.^{[18]XResearch source}
6
Add the security agreement. If the borrower is pledging collateral, you’ll need to include a security agreement. Search online and in legal books for a sample security agreement. The agreement must include a clear statement that the borrower is granting you a security interest in the specific property.^{[19]XResearch source}
- You must also describe the collateral in sufficient detail so that it can be identified. For example, don’t identify a car as “The borrower’s car.” Instead, include the make, model, and Vehicle Identification Number (VIN).
7
Sign and distribute copies. Both you and the borrower should sign the promissory note in front of a notary public. Hold onto the original document and give the borrower a copy.
- Don’t give the borrower the money until the sign the promissory note.^{[20]XResearch source}
8
Perfect your security interest. In the U.S., you’ll need to file legal documents with your state’s Secretary of State. This paperwork is necessary in case the borrower tries to use the property as security for other loans. Typically, you must file a U.C.C. statement. There should be a financing statement form, UCC-1, you can fill out.^{[21]XResearch source} Either your Secretary of State will have it or you can find one online.
- The process for perfecting in your jurisdiction might be different than in the U.S. Search online or consult with an attorney.
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Part 3

Part 3 of 3:

Collecting Payments

Keep careful records of every payment made and the date received. Detailed records will keep any disagreements from breaking out.^{[22]XResearch source} You should probably send the borrower confirmation when you receive payment. For example, you can send an email.
Call as soon as the payment deadline passes. Ask what’s going on. The borrower might have simply forgotten to pay you. Alternately, they might be struggling financially. Whatever the reason, you need to call them and find out.
3
Send past-due notices. If the borrower doesn’t pay you back, you need to document the missed payments. Send past-due notices at the 30, 60, and 90-day marks. This may seem like a hassle, but you need to document everything to protect yourself.
- Each notice should be slightly different. At 30 days, you simply remind the person that they are late with their payment. At 60 days, you can tell them they owe you late fees or penalties. At 90 days, tell them you are considering bringing a lawsuit.
- Remember to send all notices certified mail, return receipt requested. Hold onto the receipt and a copy of the letter.
If the loan was secured, you can demand collateral when the borrower stops making payment. If the borrower won’t hand it over, you can go take it. However, you can’t breach the peace when you collect the collateral. This means you can’t break into someone’s property or use violence or threats to take it.
5
Bring a lawsuit, if necessary. When a person refuses to make payment, you can sue. Of course, all you will get is a money judgment for the amount that you are owed. However, you can take other steps to collect on your judgment, such as levying the debtor’s property or garnishing their wages.^{[23]XResearch source}
- Consult with an attorney about bringing the lawsuit. They can help you identify your best course of action.
- If the amount owed isn’t much, you can sue in small claims court.
- Don’t delay. You only have so much time to sue on an unpaid debt. This time period is called the “statute of limitations,” and it differs depending on your jurisdiction. For example, in Florida, you get five years to sue. However, in Illinois, you get 10 years.^{[24]XResearch source}
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Tips

Consider running a credit check, especially if you don’t know the person very well. Anyone can claim to make a lot of money and have few debts. You should check for yourself by obtaining a credit report on the person. You will need their personal information and permission. Many companies advertise their services online.
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Warnings

Think carefully before lending to family or friends. You might harm your relationship if the borrower doesn’t repay you. Instead of lending to them, point them toward banks, credit unions, and online lenders who are more likely to extend a personal loan.
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