A loan agreement is a document between a borrower and lender detailing a loan repayment schedule. AIO Legal Services tailors Loan Agreements that can be used for business loans, student loans, personal loans between friends, family and more.
We understand that you may need to borrow money from family or friends from time to time. To make this easier, we are explaining to you how the Loan Agreement is drafted, allowing you to understand repayment terms, interest rates, even late payment penalty rules so that you can create an idea of how your potential loan will be repaid.
Loan agreements, like any contract, reflect an “offer,” the “acceptance of the offer,” “consideration,” and can only involve situations that are “legal” (a loan agreement involving heroin drug sales is not “legal”). However, Loan agreements offered by regulated banks are different from those that are offered by finance companies in that banks receive a “banking charter” granted as a privilege and involving the “public trust.”
The parties involved in a loan agreement
There are three main parties involved in a loan agreement:
The borrower: is the person who is borrowing money from the lender and will be responsible for paying it back.
The lender: is the person or company who is lending the money to the borrower. The lender has a legal right to take action against the borrower if the borrower does not repay any amount that is due under the loan agreement.
A guarantor: is someone who agrees to repay a loan if the borrower defaults on payment but also does not benefit from the loan itself. A guarantor may be held liable for repaying all or part of a loan on behalf of the borrower (subject to certain defences).
When writing a loan agreement, it is essential to keep it simple by covering the key elements:
1- The loan amount and Payment plan
Loan Amount
This will be the total dollar amount borrowed, apart from any interest or fees.
Payment Plan
This details how and when payments are to be made by the borrower, including due date and late payment consequences. If interest is charged on the loan, then this section should describe the interest rate and whether it is fixed or variable.
2- Interest on the loan
Most loan agreements contain a provision to the effect that any interest accrued over the period of the loan agreement shall be paid by the borrower to the lender at the end of the term. In practice, this usually means that if you decide to pay off your loan early, you must still pay interest accrued up until the date of payment. If you want to avoid this, you need to negotiate with your lender before you sign your agreement. You can either:
Negotiate for a reduced rate of interest for any payment made over a certain amount of time (for example, if you pay off your loan within one year or less, then no interest is charged); or agree that no interest will be charged on any amounts paid early.
You should also consider whether you would like to:
agree on a fixed term for repayment; or
agree on a maximum term for repayment (for example, three years).
Interest rates are often specified in percentages per annum (i.e., per year). In most cases, the rate is fixed throughout the life of a loan and calculated monthly. For example, 5% annual interest payable monthly will require borrowers to repay an extra 0.41667% every month.
3- Payment schedule (when are payments due)
A payment schedule in a loan agreement is a table or calendar that shows how and when the borrower will repay the lender. Each month, the borrower must make a payment of principal and interest. The number of payments, the amount of each payment, and the frequency of payments are all specified in the loan agreement. A payment schedule may also include any late fees to be charged if payments are not made on time.
A payment schedule makes it easier for borrowers to know exactly how much they owe every month, and helps lenders track whether payments have been made as agreed.
4- Late payment penalties
The reason for late payment penalties is to discourage late payments from borrowers and provide a source of compensation for the lender due to the payment delay.
Late payment penalties are typically a fixed amount that is added onto the next regularly scheduled loan payment or as an additional lump sum payment when the borrower makes the delinquent loan payment.
5- Repayment trigger
A repayment trigger is a mechanism in a loan agreement that requires the borrower to repay all or a portion of the loan balance if certain conditions are met. The repayment triggers may be based on the borrower’s credit rating, business performance, or other financial metrics.
Common triggers include:
- Breach of contract: violating the terms of the loan agreement
- Bankruptcy filing: automatically requiring accelerated repayment of principal and interest.
- Sale of collateral: requiring the sale of the collateral (the asset used as security for the loan) and use of proceeds to repay any unpaid portion of the debt.
- Insolvency or liquidation: declaring bankruptcy or converting into another type of entity, such as a limited liability company.
Finally, It does not matter whether you are an individual, group or a company, but having a solid loan agreement is vital for any form of business regardless of the nature and size of the project. We have provided all the relevant information that you need to understand so that you can deal with your future loan without hesitation. However, AIO Legal Services can draft for you a strong Loan Agreement and ensure everything is clear and documented to prevent anything goes wrong in the future.