Loans between individuals: with or without a contract?

by Lisa Baker

Loan between individuals: what does it consist of?

A loan between individuals is a good option if you need borrowed money and the requirements requested by banks are not met. Generally, a loan of this nature must be accompanied by a document called a loan agreement between individuals, which reflects all the legal conditions that will govern it.  

This type of loan can be free (without interest) or for profit (with interest). These contracts are subject, but exempt, to the  Tax on Patrimonial Transmissions  and documented legal acts, that is,  Model 600.  In other words, the loan between individuals is exempt from taxation (it will not be necessary to pay the tax), but it will be mandatory to present the  model 600 Treasury.

Next we will see the characteristics of  loans between individuals, with or without a contract.

If there is no contract, what problems can I have?

According to the Personal Income Tax Law, in a  loan between individuals, the Treasury can assume that there will be a remuneration and will force the lender to declare the interests in personal income tax , whether or not there is any. The legal interest rate of the money will be the one that will be applied, which is currently 3%. If we establish a contract between both parties , the Treasury will not apply this interest, and the lender will not have to pay taxes for possible interest. 

Another problem that we can find is that the Treasury considers that it is not a loan between individuals, if not a disguised donation, with the aim of not paying interest. Any donation is subject to the Inheritance and Gift Tax , while the loans are subject to the Property Transfer Tax , but with the contract for loans between individuals (Model 600) they will be exempt . 

In addition, since they are long-term operations, it can happen that the borrower and / or lender die.  As we know, debts are not extinguished by death and will pass to the heirs. What happens then?

  • If the borrower dies , the debt will be incorporated into the inheritance and it will be his heirs who pay the debt.
  • If the lender dies , the debt will be a right in the inheritance and one or more heirs will be the ones who receive the money. 

If it is a loan between relatives , the child who received the money will become a debtor and heir, therefore the debt will be extinguished , unless there are more heirs and they want the part of the money that belongs to them. 

Loan contract between individuals

contract for the loan between individuals is ideal, since it is useful to formalize the agreement between both parties, and you will have to register with the Treasury to be effective. Depending on whether or not the loan between individuals will bear interest, the contract model will be one or the other.

The most important aspects that the contract for a loan between individuals must collect is:

  • Date and place 
  • Personal data of the borrower and lender
  • Amount to lend
  • Loan duration
  • Whether or not interest will be applied and the rate 

Below we show you an example of a loan agreement between individuals with interest and another without interest. 

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