Private money loans bypass traditional bank underwriting, but that freedom comes with paperwork—lots of it. Without proper documentation, you risk legal disputes, tax complications, and deals falling apart at closing. Here's exactly what you need to gather and execute to protect yourself.
Why Documentation Matters for Private Loans
Banks use standardized docs because decades of defaults taught them lessons. Private lenders skip that infrastructure, which means you become the infrastructure. A single missing promissory note or unclear repayment schedule can spiral into months of legal friction if the borrower defaults or the lender changes their mind. Documentation isn't bureaucratic theater—it's your safety net.
Core Documents You'll Need
Promissory Note This is the legal IOU. It specifies the loan amount, interest rate (typically 8–15% for private money), repayment schedule (monthly, quarterly, or at maturity), and consequences of default. Most private lenders include a prepayment clause allowing early payoff without penalty, though some charge 1–3% prepayment fees. Have an attorney draft or review this; templates exist online, but state laws vary significantly.
Loan Agreement The promissory note covers payment mechanics; the loan agreement governs everything else. It includes loan purpose, disbursement terms, what triggers default, late fees (commonly 5–10% of the payment), and dispute resolution. For real estate deals, specify whether the loan is secured or unsecured. Secured loans include a deed of trust or mortgage; unsecured ones rely on personal creditworthiness.
Truth in Lending Disclosure (TILA) Federal law requires this for consumer loans under $25,000 (some states extend this). It breaks down the annual percentage rate (APR), finance charges, payment schedule, and total interest paid. Many private lenders skip this for business or investment property loans, but if you're lending to someone for personal use, include it to stay compliant.
Security Agreement or Mortgage If collateral secures the loan—real estate, equipment, inventory—you need a recorded security agreement or mortgage. Registration costs $50–300 depending on your state and lender, but it legally protects your position if the borrower defaults or files bankruptcy. Without it, you're an unsecured creditor competing with banks and suppliers for recovery.
Proof of Funds Lenders must show they have the money to lend. A bank statement, investment account screenshot, or letter from their financial institution dated within 30 days proves liquidity. This prevents scams and demonstrates the lender is serious.
Personal Financial Statement Borrowers should provide balance sheets showing assets, liabilities, income, and net worth. This isn't as rigorous as a bank underwriting process, but it gives you a baseline to assess repayment capacity. For real estate investments, include rent rolls or property appraisals if the deal is backed by real property.
Documentation Steps in Order
- Agree on terms verbally – interest rate, loan amount, repayment timeline, collateral (if any).
- Draft the promissory note and loan agreement – use a template as a starting point, then have an attorney review for $300–800. Non-negotiable if the loan exceeds $50,000.
- Exchange proof of funds and financial statements – borrower provides these, lender confirms ability to fund.
- Record security documents – if collateral is involved, file the mortgage or deed of trust with the county recorder's office.
- Fund the loan – wire transfer or cashier's check; request written confirmation of receipt.
- Store originals securely – locked filing cabinet or safe deposit box. Keep digital scans backed up separately.
Typical Timelines and Costs
Documentation for a straightforward $50,000 private loan takes 1–3 weeks end-to-end. Attorney fees range from $500–1,500 depending on complexity and your location. Real estate-backed loans require title searches ($200–400) and recording fees ($50–300). Compare lenders and service providers on Mercoly to find vetted private money sources that handle documentation transparently.
Red Flags to Avoid
Don't accept verbal-only agreements. Don't skip the promissory note to "speed things up"—you'll regret it. Avoid lenders who won't sign standard documents or insist on non-standard terms without legal counsel review. If collateral is promised, never fund before the security agreement is recorded.
Frequently Asked Questions
Q: Can I use an online template instead of hiring an attorney? Templates work for straightforward loans under $25,000, but they miss state-specific requirements and nuance; for larger amounts or real estate, attorney review costs far less than litigation later.
Q: How do I report a private loan to the IRS? Lenders report interest income on Form 1040 Schedule B; borrowers may deduct interest if the loan finances business or investment activity—document the loan's stated purpose in writing.
Q: What happens if the borrower doesn't pay? It depends on whether the loan is secured; unsecured loans require a lawsuit and judgment before collection, while secured loans let you foreclose on collateral faster.
Start documenting now—your deal depends on it.