To write a promissory note for a personal loan, put six things on paper: the full legal names and addresses of the lender and borrower, the exact principal amount, the interest rate, the repayment schedule and maturity date, what happens if the borrower defaults, and both signatures. Everything else in a good note either sharpens one of those six items or protects the lender if the borrower stops paying. If the loan is between family or friends, the interest rate also has to clear an IRS threshold called the applicable federal rate, or the loan creates tax consequences you didn’t plan for.
What the Note Must Contain
A promissory note becomes enforceable when it contains an unconditional promise to pay a fixed amount, is payable on demand or at a definite time, and names a specific payee.1LII / Legal Information Institute. UCC 3-104 – Negotiable Instrument Working from that framework, include the following at a minimum:
- Full legal names and current residential addresses for both parties. Nicknames or initials invite identity disputes later.
- The principal amount, written in both words and numerals.
- The interest rate, and whether it is simple or compound.
- The date the loan is made or funded.
- Repayment terms, including how the borrower pays, when payments are due, and a maturity date for full repayment.
- A governing law clause naming which state’s laws apply. This matters when the lender and borrower live in different states.
Both parties need to be legal adults with the capacity to understand the agreement. Anyone under 18 can generally void a contract they signed, so a note against a minor borrower is unenforceable. A person who lacked the cognitive ability to understand the terms when they signed can also challenge the note later.
Setting a Legal Interest Rate
Every state sets a maximum interest rate for private loans, and the caps vary widely. Some states cap rates as low as 6%, others allow 30% or higher, and a handful impose no general cap. Look up the usury limit for the state whose law governs your note before you pick a rate. Charging more than the legal maximum can void the interest entirely, and in some states, the lender forfeits the right to collect the principal too.
Simple or Compound
Simple interest charges only on the original principal. A $10,000 loan at 5% simple interest for three years produces $1,500 in interest, the same $500 each year. Compound interest charges on the principal plus any accumulated interest, so the balance grows faster. Simple interest is more common in personal loans between individuals and easier to verify. If you use compound interest, specify the compounding frequency (monthly, quarterly, annually) so the borrower can check the math. A note that just says “5% interest” without saying simple or compound sets up an argument later.
Choosing a Repayment Structure
Three structures cover most personal loans:
- Lump sum. The borrower pays principal and interest in one payment on a set date. This fits short-term loans where the borrower expects a specific inflow like a tax refund or bonus.
- Installments. Payments are spread over a regular schedule, usually monthly. Specify the exact payment amount, the day of the month it is due, and where to send it. Include a maturity date as a hard deadline.
- Demand. The lender can call the entire balance due at any time. This gives the lender maximum flexibility but requires the borrower to stay liquid.2LII / Legal Information Institute. Demand Note
For installment loans, state explicitly that each payment applies to interest first, then principal. Without that instruction, a dispute over the remaining balance is almost inevitable.
Default, Late Fees, and Acceleration
A note without default provisions is a contract without consequences. Address each of the following.
Late Fees
Late fees are usually a percentage of the missed payment, commonly around 5%. Set a grace period of 10 to 15 days after the due date before the fee kicks in. Keep the fee reasonable; courts in many states will refuse to enforce penalties that look punitive rather than compensatory.
Acceleration Clause
An acceleration clause lets the lender demand the entire remaining balance immediately if the borrower defaults. Without one, a lender on an installment note has to chase each missed payment individually. When acceleration is invoked, the borrower owes the unpaid principal plus interest accrued before the acceleration, but not the future interest that would have come due over the rest of the loan.3LII / Legal Information Institute. Acceleration Clause
Attorney Fees
Without an express provision, each side pays its own attorney fees in a collection lawsuit. If you want the borrower to cover legal costs on default, put it in the note. A clause requiring the defaulting party to pay reasonable attorney fees and court costs is safer than a fixed percentage, which courts may cut down.
Prepayment
Decide upfront whether the borrower can pay off the loan early without penalty. Most personal loans between individuals allow prepayment freely, but if you are counting on the interest income, you can include a prepayment penalty. Say whether it is a flat fee or a percentage of remaining interest.
Secured or Unsecured
An unsecured note is backed only by the borrower’s promise. If they default, your recourse is a lawsuit and then trying to collect on the judgment. A secured note ties the loan to specific collateral, such as a vehicle, equipment, or a financial account. If the borrower defaults, you have a claim against that property.
Describe the collateral specifically enough that someone could identify it without guessing: make, model, year, and VIN for a vehicle; serial numbers for equipment; account numbers for financial assets. Vague descriptions like “my car” weaken the security interest. Depending on the collateral and your state’s rules, you may also need to file a UCC financing statement to perfect your interest, meaning your claim is formally recorded and takes priority over other creditors.
The IRS Rules on Loans Between Individuals
This is where family and friend loans go wrong. The IRS does not let you lend at an artificially low rate without tax consequences. Skip these rules and you can owe tax on interest income you never actually collected.
Applicable Federal Rate and Imputed Interest
When a loan between individuals charges less than the applicable federal rate (AFR), the IRS treats the difference as imputed interest. The lender is taxed as if they had received interest at the AFR, and the forgone amount may be treated as a gift from lender to borrower.4Office of the Law Revision Counsel. 26 U.S. Code 7872 – Treatment of Loans With Below-Market Interest Rates The IRS publishes AFRs monthly, and they depend on the loan term:
- Short-term (3 years or less): 3.59% for March 2026
- Mid-term (over 3 years, up to 9 years): 3.93% for March 2026
- Long-term (over 9 years): 4.72% for March 2026
These rates assume annual compounding and change each month.5Internal Revenue Service. Revenue Ruling 2026-6 The rate in effect when you make a term loan applies for the life of that loan. For demand loans, the rate resets each period.
The $10,000 Exception
If the total outstanding loan between two individuals stays at or below $10,000, the imputed interest rules do not apply.4Office of the Law Revision Counsel. 26 U.S. Code 7872 – Treatment of Loans With Below-Market Interest Rates The exception disappears if the borrower uses the money to buy income-producing assets like stocks or rental property. For loans between $10,000 and $100,000, the imputed interest is capped at the borrower’s net investment income for the year.
Reporting Interest and Gift Tax
Any interest you receive is taxable income and must be reported on your federal return, even if no Form 1099-INT is issued.6Internal Revenue Service. Topic No. 403 – Interest Received If you collect $10 or more in interest from a borrower during the year, the borrower is technically required to file Form 1099-INT.7Internal Revenue Service. Instructions for Forms 1099-INT and 1099-OID If you forgive part or all of a loan, the forgiven amount is treated as a gift, as is the imputed interest on a below-market loan. For 2026, the annual gift tax exclusion is $19,000 per recipient; forgiven amounts below that threshold don’t require a gift tax return.8Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 Larger forgiveness amounts require Form 709, though they rarely produce actual gift tax because of the lifetime exemption.
Signing the Note
A promissory note does not need to be notarized to be enforceable. The borrower’s signature alone makes it binding. Notarization adds proof that the signer is who they say they are and signed voluntarily, which helps if the note ends up in court. A witness (or two, depending on your state) serves a similar purpose at no cost.
Electronic signatures are also valid. The federal ESIGN Act provides that a contract cannot be denied legal effect solely because it was signed electronically,9Office of the Law Revision Counsel. 15 USC Ch. 96 – Electronic Signatures in Global and National Commerce and this covers promissory notes for personal loans. Both parties must affirmatively consent to electronic delivery and be told they can receive paper copies.10National Credit Union Administration. Electronic Signatures in Global and National Commerce Act – E-Sign Act
Storing and Enforcing the Note
Keep the original signed note in a secure location like a fireproof safe or a bank deposit box. Both parties should hold a fully signed copy. Digital scans are fine as backups, but courts often require the original when enforcing a note, so don’t rely on a PDF alone.
If the borrower stops paying and informal efforts fail, the note gives you a clear path to court. Small claims handles smaller balances; larger amounts go to a higher court where legal costs add up quickly. That is why the attorney fees clause matters: without it, winning can still mean losing money on legal bills.