Why a Promissory Note Is Important Between Friends & Family

A promissory note is a document that includes a promise to repay a loan, the loan amount and the repayment terms. Think twice about making loans, especially if doing so could leave you short of money to pay household expenses. Avoid the temptation to skip writing a promissory note if you do lend a friend or family member money. The note can help you recoup your money if the borrower reneges on the promise to repay you.

Relationship Preservation

A promissory note can help protect your relationship with friends or family members and prevent misunderstandings after you lend them money. The note moves the loan beyond your personal relationship and makes it a business transaction. Friends and family members shouldn't take offense to signing a promissory note because you're giving them a loan when a bank probably won’t. A promissory note also makes it clear to everyone involved that the money you're providing isn't a gift.

Payment Schedule

Sometimes family and friends may think it's OK to blow off repaying a loan to you because you’re not a traditional lender. A promissory note helps prevent that notion by formalizing the repayment schedule the way a bank does. For example, the note may say the borrower has to make payments in a specified amount on the first day of each month until the loan is repaid. Give the borrower a receipt for each payment and keep a copy on hand to avoid disagreements over how many payments you’ve received.

Tax Issues

Money you give friends or family members can have tax consequences. A promissory note provides official documentation of a loan if the Internal Revenue Service ever audits you. For 2012, for example, taxpayers can give someone up to $13,000 without having to pay a gift tax. You can avoid the tax if you lend someone more than that and cite an interest charge on the promissory note. However, the interest charge on the loan must at least equal the most current applicable federal rate listed on the Internal Revenue Service website.

Considerations

Examples of promissory notes for personal loans are available online free of charge, or for a fee. You may want an attorney to write a promissory note for you to ensure the loan terms are correct. Some friends and family members won't repay a loan even if they sign a promissory note. So, you may have to sue them in small claims court to get your money back. In such cases, the promissory note will serve as proof to a judge that you made a loan that the borrower agreed to repay.

 

About the Author

Frances Burks has more than 15 years experience in writing positions, including work as a news analyst for executive briefings and as an Associated Press journalist. Burks has banking and business development experience, and she has written numerous articles on consumer issues and home improvement. Burks holds a bachelor's degree in political science from the University of Michigan.