An employee loan agreement is a contract that acts as a framework for when a company lends an employee money. It establishes important terms such as the loaned amount, the interest rate, the length of the contract, and the rules regarding repayment. By drafting a loan agreement template, a company can establish a standard lending process for their employees, ensuring terms remain fair and consistent from one loan to the next.
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What is an Employee Loan Agreement?
An employee loan agreement is a form used to document that a business lent money to one of their employees. The money can be provided to aid an employee with a major life expense (from school tuition to homeownership), to near-term expenses they can’t afford due to a financial crisis (such as rent, food, car payments, and more). Regardless of the reason the employee was provided money, they will be expected to pay back the loan over a specific amount of time, with interest.
Pros & Cons of Lending to Employees
Pros
- Improves employer-employee relations – Helping an employee in need aids in breaking down the corporate “wall” from employer to employee, and aids in forming a strong bond with the employee.
- Increases employee productivity – Financial worries can weigh an employee down heavily, and reduce their concentration on their tasks at hand.
- Promote company image – While this should be an afterthought for the business that decides to loan to their employees, it is a welcome benefit.
Cons
- Could face more loan requests – If employees learn that another employee received a loan, they could make the same request to the employer. A company should not offer a loan to an employee unless they’re willing to offer a loan to all employees.
- Risk of losing the loaned money – There’s always a chance that the employee defaults on the loan. This risk is decreased if the employer deducts loan payments from the employee’s paycheck – but the risk of them quitting (and leaving the loan unpaid) remains the same.
- Can complicate taxes – if the employer doesn’t issue the loan correctly or they fail to match the AFR for loans over $10,000, they can complicate their taxes significantly.
- Discrimination issues – if an employer grants a loan to one employee, but denies a loan to another employee (even if the reason is valid), the company can open itself up to a potential discrimination lawsuit.
How to Loan to an Employee
The steps below outline the first-time process an employer should take when loaning to an employee.
Step 1 – Understand the Employee’s Needs
Before deciding to loan to an employee or not, understand exactly why they need the money. If the employee has deep-seated money management issues, a loan will most likely serve as a temporary “band-aid” for their issues, and could even worsen their financial situation. However, if the employee was faced with a medical crisis and is in medical debt (for example), a loan could make a major difference in their life. At the end of the day, the decision is up to the employer.
Step 2 – Establish a Lending Procedure
To simplify any future loans the company may issue, they should establish a standardized policy that clearly informs employees the types of loan terms they qualify for, what the disqualifying criteria is (if any), and the maximum amount ($) that can be lent. Also included in the policy should be the name(s) of those that can grant authorization for a loan and the exact process employees need to follow in order to acquire a loan.
Step 3 – Set the Rate
For loans above $10,000, the employer will need to charge the employee an interest rate at or above the current AFR (Applicable Federal Rate). A list of the current rates can be found at the IRS’ Index of Applicable Federal Rates Rulings.
Step 4 – Create & Sign the Loan Agreement
The loan agreement will need to establish the major terms of the loan, including:
- The names of the employer and employee;
- The date the parties are entering into the agreement;
- The amount of the loan ($);
- The interest rate;
- The amount ($) the employer will deduct from the employee’s paycheck to pay for the loan;
- The date of the first payment;
- What happens should the employee default on the loan; and
- The signatures of the employer and employee.
The employer should keep a version of the loan agreement as a template. By pre-filling out fields that will often remain unchanged (such as the company name and address), the company can use the document repeatedly for any future loan agreements they enter.
Step 5 – Keep Records
Regardless of the amount loaned, employers should keep diligent records of every loan made to an employee. A copy of the loan agreement should be kept in a secure place, and the loan itself should be accounted for in the company’s books. If the loan will be paid within a year, the company should list the loan as a “current asset” in its balance sheet. If over a year, it should be considered a “long-term asset”.