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A Loan Agreement is a contract between a borrower, who is looking for money and a lender, who is willing to provide the capital to the borrower.
A commercial loan agreement is one by which a company acts as a borrower. A personal loan depends on the income and assets of the individual requesting a loan. In all cases, lenders will want assurance for repayment. A Loan Agreement is essential for this.
A loan can be secured or unsecured, but in the case of a secured document, additional security documents are required.
What is in a Loan Agreement?
All loan agreements will contain details about the borrower and lender. Also, the amount that needs to be borrowed and other terms and conditions for repayment. Always ensure that the agreement spells out the payment details. Especially because there is always an off-chance there are late payments or default.
The Principal or Borrowing Amount
The principal amount to be borrowed is the actual money that will be lent to the borrower at the beginning of the loan. As you pay the loan off, the principal balance will update to reflect the balance remaining.
Loan Agreement Term
In essence, the term of the loan agreement specifies how long the loan will be active and how often the loan payments will occur. At the end of the loan term, it is typical that the borrower will pay off the remaining principal of the loan in full.
Essentially, the interest rate is used to calculate the loan payment that needs to be made at the specified loan term. Typically, interest rates for loan agreements are set out as an annual or monthly number.
Importantly, ensure that payment details in the loan agreement are accurate. These details specify when to make the payments and (for example, 5th day of each month) and how to make these payments.
Late Fees and Default
Generally, the loan agreement can specify any fees to pay if the monthly payments are late. In the unfortunate event that payments cannot be consistently met, the loan will be in default. Specify in this area under what conditions the loan will be in default.
Specifically, you can secure certain loans with collateral. These are called secured loans. Essentially, the collateral is typically an asset that has monetary value. The assets can be a hard asset. For example, cars, houses, etc. Or, those assets can be less tangible such as invoices and accounts receivables. Basically, this collateral allows the lender to monetize the assets in the event of default.
When should you use a loan agreement?
Essentially, a loan agreement protects the lender in the off chance that a borrower is not able to repay the obligation. As a borrower, this document also provides a framework for the details of the loan and how the payment terms.
Should I have a secured or unsecured loan agreement?
In essence, the lender will specify whether or not you can secure the loan by collateral. Or, whether it can be unsecured. This is likely to be via a personal guarantee. Ultimately, the lender will make this decision after considering the background of the borrower in combination with the risk tolerance of the lender.
Pre-Payment Fees and Penalties
A borrower’s goal will always be to pay back the loan as soon as possible. But they can be penalized for doing so as lenders have an expectation as to how much return they will receive after a certain time. A prepayment will mean that the lender will not be receiving the expected interest. Hence pre-payment penalties are put in place to protect the lenders.
Prepayment penalties are usually some percent of the amount due on the loan or six months of interest payment.
What is sharking?
Sharking is a practice where an individual or an organization illegally charges a higher interest rate exceeding the legally permitted maximum rate, which is also known as the Usury rate. It is a predatory way of lending money that might not be deceitful but is illegal under the law.
What does consolidate mean?
Consolidate is the act of taking one sizable loan to pay off or clear other loans by having only one payment to make regularly. It is a good, simple, and less hasslous way of clearing debts if one can find a low-interest rate.
In summary, a loan agreement protects both parties as it provides a mutual understanding of the repayment of the loan over time. For the lender, especially, use this template to mitigate any risk with the borrower.
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Along with this document, make sure you see these other templates in our library:
- Shareholder Agreement
- Personal Guarantee
- Promissory Note
- Share Appreciation Rights Plan
- Revolving Loan Agreement
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