Record the loan itself
When the lender funds the loan, the money arrives in your bank account. Create a liability account for the loan, named for the lender. Then record a deposit: the bank increases and the loan liability increases by the same amount. Income is not involved.
If the lender takes fees out of the proceeds, record the fees as an expense or as a cost to be spread over the loan term. Your CPA can advise on which treatment applies.
Split each payment
A payment contains principal and interest. Principal reduces the loan balance. Interest is an expense of borrowing. The lender's amortization schedule or monthly statement shows the split. Use it, not an estimate.
Enter each payment as a transaction with two lines: one to the loan liability for the principal and one to interest expense. The total equals the payment from the bank.
Use the amortization schedule
Ask the lender for the schedule at closing, or generate one using the rate, term and amount. Early payments are mostly interest, and later ones mostly principal. A schedule saves time and lets you spot an error if the lender's balance does not match yours.
For loans with variable rates or interest-only periods, the numbers change, so check each statement.
Special cases
Lines of credit work similarly, but balances go up and down. Record draws as increases to the liability and repayments as decreases. Loans from an owner should be documented in writing and kept in a separate liability account so they are not confused with equity.
Equipment loans link the purchase and the loan. Record the equipment as an asset and the loan as a liability, with no cash flowing in if the lender pays the seller directly.
Reconcile and review
Each quarter, compare your loan balance to the lender's statement. Differences come from missed interest, fees, late charges or wrong splits. Fix them promptly.
At year end, ask the lender for the interest paid summary and compare it to your expense total. If you plan to borrow again, a clean loan record shows lenders you keep careful books.
Mistakes that distort profit
The two biggest errors are recording the loan deposit as sales and recording the whole payment as an expense. The first inflates income in the month of funding and may trigger taxes you do not owe. The second understates profit every month afterward and leaves a liability that never shrinks.
If you find either error, correct it with an adjusting entry and tell your tax preparer, especially when a closed tax year is affected.
Keep the loan agreement, the amortization schedule and each year-end lender statement in one folder, named by lender. Lenders and tax preparers ask for these, and having them together saves a scramble. If you refinance or pay off the loan early, record the payoff the same way as a normal payment, splitting any final interest and fees, then close out the liability account.
Common questions
Is a loan deposit income?
No. It creates a liability. Only the interest is a cost.
Where do loan fees go?
Often to expense, or spread across the term. Ask your CPA about the right treatment.
What about a forgiven loan?
Forgiveness can have tax consequences. Ask your tax preparer before recording it.
This guide is general information, not tax, legal or accounting advice. Rules, fees and due dates change; check with the IRS, the NJ Division of Taxation or a licensed professional for your situation.