A Guide to Personal Loans

For many people, the thought of applying for a loan conjures up images of stodgy bankers sitting behind big desks in a cavernous marble bank. These images can be pretty intimidating to a person seeking his or her first loan or someone with a less than stellar credit score. Fortunately there is an alternative to borrowing from the traditional bank. In almost every respect, a personal loan is the same as a loan from a bank. The main difference is that the lender is a friend or relative.

There are many reasons why borrowers would prefer a personal loan to a traditional loan, including:

  • They don’t have a credit record
  • They have a poor credit record
  • They can’t find a bank to loan them money
  • The terms set by the bank are too expensive
  • They have a friend or family member willing to negotiate a personal loan

While a personal loan can make more sense than a traditional loan, it has to be set up properly. A handshake or verbal agreement can be quickly forgotten or misinterpreted by one of the parties. If both parties are not on the same page regarding their responsibilities in a loan, it can quickly lead to personal acrimony and poison the relationship that brought the two parties together. The best way to prevent this type of situation is for both parties to negotiate and sign a loan agreement (or promissory note) and track the performance of the loan using a service like LoanBack.

When negotiating your loan there are several components to consider:


Loan Purpose

Whether the loan is going to be used to finance the purchase of a car, a new home or just pay off credit card debt, both parties must have a clear understanding of how the money is going to be used.


Loan Amount

The loan amount (or principal) should be clearly stated in the loan agreement and should be clearly linked to the loan purpose so the lender is confident that the loan is being used for the stated purpose of the loan. The loan amount is also required to set up the amortization or repayment schedule.


Loan Interest Rate

Depending on the loan purpose and amount, there are different benchmarks you can use when setting up your personal loan. It’s critical that both parties select a realistic interest rate. If it is prohibitively high it will be harder for the borrower to repay the loan and might even violate your state’s usury (excessive interest) limits. If the rate is too low the IRS might actually consider the loan a gift instead of loan, resulting in taxes to be paid by the lender. For more information check out “How to Determine the Interest Rate on a Personal Loan”


Loan Term

The loan term is the amount of time the borrower has to pay back the loan measured in months or years.


Amortization Schedule

The amortization or repayment schedule is a table that shows the payments to be made over the loan term. The regular payments can include interest and principal components or interest payments only with a balloon payment of principal at the end of the loan term. The amortization schedule also details the frequency of payments. The most common payment schedules are monthly, bi-monthly, quarterly or weekly.


Loan Security and/or Special Terms

The loan security (or collateral) details assets that will transfer to the lender in the event that the borrower cannot repay the loan or meet other obligations detailed in the loan. A loan without any collateral is known as an ‘unsecured loan’. The most common form of collateral for a loan is the asset purchased with the loan amount (e.g. the title to a car, the deed to a loan, equipment purchased from a business loan, etc.).

Once both parties have agreed on the basic components of the loan, its time to create and sign a formal loan document. At LoanBack, your loan document will be automatically generated and ready to download as a PDF file after you have built your loan using our loan wizard. Once your loan has started you can also use LoanBack to set up regular payment reminders and track payments online.


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