How to Draw up a Loan Agreement That Includes Amount, Interest and Monthly Payment Schedule

Payment formula.

This article covers the basics of drawing up a promissory note. If you are a mentally competent adult over the age of 18, you can enter into such an agreement. The lender and borrower are known as the parties to the agreement.

Difficulty:

Easy

Instructions

1. Get it in writing. Even though oral contracts are enforceable, it's a good idea to get the agreement in writing, in case the parties disagree about the terms, the borrower declares bankruptcy or one of the parties becomes ill or dies.

2. Decide who will sign the note. If the money is being loaned to two parties, they should be jointly and severally liable for the note so that if one fails to pay, the other is responsible for the entire amount of the note.

3. Will there be security? Car loans, as one example, are secured by the vehicles financed, so they are usually easier to get than other loans.

4. Set the interest. Even if you are lending to friends or relatives, setting a fair interest rate is a good idea. It furnishes incentive to pay off the loan as scheduled and lets both parties know that this is a serious, not casual, matter. If you are the lender, remember that you will lose money if you simply loan your money without some sort of earned return.

5. Determine the payments. Payments are set by the formula attached as an illustration to this article:

   M = Payment amount
   P = Principal amount borrowed
   i = Interest rate per payment period
   N = Total number of payments

   A far quicker way to determine the payment amount, set interest rate and get an amortization schedule is to plug the numbers into various free online calculators that are available (see resources).

6. Study the amortization schedule. The amortization schedule shows how much of your periodic payments will go toward the principal and how much will go toward interest. You can plot it out manually by subtracting the payment period's interest from the formula I presented or by selecting the amortization schedule from the website calculator you choose. It's good to understand how loans like this are structured. By far, most of the early payments on a loan go to interest and not principal. Depending on the duration and interest rate, it can take years before you make a substantial dent in what you have actually borrowed.

7. Use this form. Here's a good basic agreement to use that's fair to both lender and borrower. The parentheses are to explain the blanks and should not be on the agreement itself. Write it up either to an individual or to partners.

   I______ (individually) or we__________, jointly and severally, promise to pay to__________ ,lender, the principal amount of _________________(written in both figures and in words) plus interest.

   Interest shall be charged at the rate of _____% (specify payment period or per year). Interest shall accrue from the date this note is signed and money loaned, until the date the note is paid off in full.

   The note shall be paid in ______(number) of installments of $_________ (dollar amount, in numerals and words) beginning on ____________ (date due) and on the _______ day of the each month thereafter until the principal and interest are paid in full.

   Each payment shall first be applied to unpaid accrued interest, and the remainder will be applied to the remaining balance of principal.

   If any payment due under this note is not received by the lender within _________ days of its due date, the entire note of unpaid principal and accrued but unpaid interest shall become immediately due and payable at the option of the lender without the need of any additional notice to the borrowers.

   If the lender prevails in a lawsuit to collect this note, I / we agree to pay the lender's court costs and attorney's fees in any amount the court finds reasonable.

   Should the borrower pay off the entire loan prior to its due date, the interest will be recalculated so that there is no prepayment penalty.

   (Date the note. Leave space for signatures of all parties, specifying whether they are the borrowers or lenders, with names written out under each and with addresses and phone numbers. Each party should get an ordinal signed and fully executed copy of each note.)

Resources

• Bankrate: Online Calculator
• Calculator-Loan: Online Calculator