Are you planning to take out a loan to fund your dream car or renovate your home?
Loans are powerful tools that you can use to grow your business so you can make thousands and millions!
However, once approved, you’ll be required to sign the loan agreement when you take out a loan.
So the question is… What’s a loan agreement?
Basically, the loan agreement is a contract where you’ll see the loan amount, interest rates, fees, and more.
The loan agreement plays a critical role as it shows what you’re really getting yourself into.
If you want to know more about what a loan agreement should include, then this is the most important blog you’ll read today.
With over two decades of experience as a banking expert and financial coach, I’ll not just show what a loan agreement is, but below, I’ll also reveal the importance and the sections included in it.
This blog can also be your guide in different terms that you might encounter in your loan agreement.
Fully understanding your loan agreement can even help you save money in the long run by identifying fees and interest rates that you might not go along with.
And without further ado, let’s get right into it!
What is a Loan Agreement?
First, let’s learn what a loan agreement is.
A loan agreement is a contract detailing crucial information and responsibilities.
It will include the loan amount, the type of loan being offered, the repayment schedule, and the interest rate.
A loan agreement is a formal accord between the lender and the borrower.
The lender’s legal counsel creates this agreement to ensure the contract’s legal enforceability.
Loan agreements are also called loan contracts, credit agreements, financing agreements, and sometimes even promissory notes.
How does a business loan agreement work?
Loan agreements are legally binding contracts, meaning the lender has the right to pursue compensation if you can’t repay the loan.
If you’ve taken out a secured loan, that means you’ve offered collateral. Lenders will have the right to seize this collateral if you can’t repay the debt.
After you apply for the loan, lenders will assess your or your business’s capability of repaying the debt.
If the lender approves the financing, that’s when the loan agreement comes up.
Lenders will now send it to you, the borrower, for review.
Loan agreements are crucial in establishing expectations and avoiding misunderstanding or causing confusion for both (which can also lead to lawsuits).
What Loan Agreements Should Include (Sections of a Business Loan Agreement)
The effective date
Your loan agreement becomes legally binding from this date forward.
Typically, this is the same date you receive the funds from the lender.
The promissory note
A promissory note is your IOU or promise to repay the lender what you borrowed with interest.
Private, non-bank lenders usually use it, typically offering shorter-term or unsecured loans.
Don’t forget that these are legally enforceable loan agreements still.
Collateral
When you take out a loan, especially a secured loan from traditional lenders like banks and credit unions, they will require you to offer collateral just in case you can’t repay the loan.
Your collateral will serve as an added security for the loan.
Terms and Conditions
This section of the loan agreement will include the key details about the loan and how you’ll repay it. Here are the terms and conditions you should see in a loan agreement
- Loan amount
- Repayment Term (how long you’ll have to repay what you borrow)
- Repayment schedule (The time when you will make repayments)
- Interest and other fees
Default clauses
Default clauses help provide clarity if the borrower ever defaults on the loan.
This should include the fines and penalties.
Many lenders offer grace periods for late payments. However, if you miss the period, you will be considered in default.
This section also typically includes an acceleration clause.
The acceleration clause, on the other hand, states that once you’ve defaulted, the lender can accelerate your repayment and demand full repayment.
If you can’t repay it in full, the lender will have the right to collect the collateral you’ve put up.
Potential Penalties
Loan agreements should have a portion that clearly explains specific penalty fees that can happen.
This can be included in the terms and conditions or in a separate section.
Check for these two potential penalties:
- Nonpayment: Borrowers who miss a payment will need to pay this fee. Check the amount and ask if you have a grace period.
- Prepayment: Unfortunately, some lenders penalize borrowers when they repay their loans ahead of schedule.
Repayment Terms
Loan agreements should also indicate how and when you will start repaying the debt.
The contract should have a clear repayment schedule.
Here are three ways how you can repay the loan:
- Payment on demand: Lenders may request this type of repayment for borrowers who have low credit. In this repayment method, lenders can require repayment at any time.
- Payment at the end of the loan term: This way of repayment has a specific date and time when you’ll repay all the debt with interest.
- Installment: Installment repayment is the most common method. This is common for loans with large loan amounts which will require periodic payments.
Jurisdiction and Governing Law
Of course, laws will differ from state to state.
Loan agreements should also have a section that says which state is responsible for governing the agreement.
This section of the loan agreement may also include the jurisdiction that will hear any disputes sent to court.
Covenants
Covenants are promises made between both parties
Generally, the lender covenants to disburse funds in a specific amount and interest rate, while borrowers will pledge to repay the debt according to the terms.
Lenders can have various conditions around the loan, and the covenant will lay all of these out.
Usually, covenants cover the loan purpose, prohibit on taking more debt until the specific loan is repaid, and are updated on your tax payments and insurance coverage.
Signatures
Finally, the last section of the loan agreement is where you’ll sign the contract.
The borrower should find a signature space designated to them, other business owners, guarantors, and of course, the lender.
The loan agreement will be effective on the specific date found in this section.
Terms to know
If you’re a new entrepreneur or business owner, there are specific terms that you should know when reviewing loan agreements.
Here are the terms that lenders commonly use:
- Acceleration: Acceleration means that the lender can ask for the full loan amount to be repaid instantly in case the borrower defaults on the loan.
- Amortization: This involves paying off your loan in planned installments, usually monthly, where each payment first covers interest and then reduces the principal.
- Annual percentage rate (APR): Reflects the yearly cost of the loan, including interest and fees.
- Balloon payment: large, lump-sum payments due later in the repayment schedule.
- Blanket lien: This gives your lender the right to seize any business asset as repayment if you default on the loan.
- Co-signer: Allows the lender to seize any business asset if you default. If someone co-signs your loan, they share responsibility.
- Cross-default provision: This means defaulting on one loan can trigger a default on others with the same lender.
- Default: Failure to repay the debt as agreed.
- Principal: The principal represents the remaining loan balance, reduced with each payment.
Business Loan Agreement: Final Thoughts
Whether you’re financing your dream car or tackling home renovations, understanding your loan agreement is crucial. It’s like a roadmap for your financial journey, outlining the loan amount, interest rates, fees, and all the fine print.
By familiarizing yourself with terms like amortization, APR, and default clauses, you’ll be able to navigate your loan confidently.
Remember, knowledge is power, and with this guide, you’re all set to make informed decisions and maybe even save some money along the way.