A private money loan can fund your real estate deal or business venture when banks won't—but only if the agreement protecting both you and the lender is airtight. Without clear terms in writing, even a handshake deal with a family member can become a costly legal nightmare.
Core Terms That Must Be Written Down
Your private money agreement needs to spell out exactly how much is being borrowed, at what interest rate, and over what timeframe. Vague understandings about "paying back when you can" invite disputes. Instead, specify whether the loan is interest-only during the term or fully amortizing, and whether there's a balloon payment due at maturity.
Interest rates for private loans typically range from 6% to 12% annually, depending on risk, market conditions, and your borrower profile. Document whether interest compounds monthly, quarterly, or annually. If you're the borrower, this detail directly impacts what you'll owe.
Collateral and Security
Most private lenders require collateral to back the loan. This is often a first or second mortgage on real property, but could also be equipment, inventory, or other assets. Your agreement should specify exactly what secures the debt and in what priority position—critical if the borrower defaults.
Include language about what happens if the collateral value drops. Does the borrower need to post additional security? Can the lender demand repayment if the property depreciates by 20%? These "maintenance covenants" protect the lender and clarify expectations upfront.
If the loan is secured by real estate, you'll need a formal promissory note and a corresponding mortgage or deed of trust, recorded with the county. This costs $300–$1,500 in legal fees but gives the lender enforceable rights.
Default and Remedies
Define what constitutes default beyond simply missing a payment. Common triggers include:
- Missing a scheduled payment by more than 10–15 days
- Failing to maintain adequate property insurance
- Selling or refinancing the collateral without permission
- Allowing tax liens or other superior liens to attach to secured property
- Material breach of any loan covenant
Specify what happens when default occurs: Does the lender have the right to accelerate the full loan balance immediately? Can they foreclose, take possession of collateral, or pursue a deficiency judgment? These remedies should be clearly itemized so both parties understand the consequences.
Payment Schedule and Default Interest
State the exact due date for each payment and whether there's a grace period. Many agreements allow 5–10 days past the due date before late fees kick in. Late fees typically range from 4% to 8% of the monthly payment or a flat amount like $50–$250.
Some agreements include "default interest"—a higher rate applied if the loan is in arrears for 30+ days. This incentivizes prompt payment and compensates the lender for increased risk.
Prepayment Terms
Can the borrower pay off the loan early without penalty? Private lenders often include prepayment penalties (typically 2–5% of the outstanding balance) to protect against unexpected payoff, especially if they planned for that interest income. Clarify whether penalties apply to full prepayment, partial prepayment, or both.
Ongoing Obligations and Reporting
Include reporting requirements: Does the lender have the right to request financial statements or appraisals? Can they inspect collateral property? If it's a real estate loan, require the borrower to maintain property taxes, hazard insurance, and homeowners association dues (if applicable).
Specify how often statements are sent—monthly or quarterly—and whether the borrower must update the lender on material changes to their financial situation or business operations.
Jurisdiction and Legal Compliance
State which state's laws govern the agreement and which court has jurisdiction if a dispute arises. This prevents conflicting legal interpretations later. Also confirm the loan complies with local usury laws; most states cap interest rates on certain loan types, and violating these caps can void the agreement or expose the lender to penalties.
Getting It Right
You can use templates online ($30–$100) or hire a real estate attorney ($500–$2,000) to draft the agreement properly. Given the sums involved, attorney fees are usually worth it. Mercoly helps you compare and find trusted private money and peer lending providers who understand what airtight documentation looks like.
Frequently Asked Questions
Q: Can a private money loan be verbal, or must it be in writing? While verbal loans can technically be enforceable depending on the state, they're nearly impossible to prove in court and invite disputes over terms. Written agreements with signatures are always safer and required if real property secures the loan.
Q: What's the difference between a promissory note and a mortgage? A promissory note is the borrower's promise to repay; a mortgage is the document that pledges property as collateral if they don't. Both are typically needed for real estate-backed private loans.
Q: Can I charge whatever interest rate I want as a private lender? No—most states enforce usury laws that cap interest rates on certain loan types. Rates of 10–12% are generally safe, but check your state's limits before finalizing the agreement to avoid legal liability.
Ready to formalize a private loan? Start by documenting every term in writing before any money changes hands.