About Loan Agreements

A loan agreement is a legal document between a lending institution and a personal or commercial borrower. This agreement features the loan amount, the repayment schedule and penalties that apply to late repayments. Loan agreements are used by banks to distribute money to college students, small business owners and homeowners in a responsible manner. Every borrower should read loan agreements carefully to avoid excessive interest rates, rapid repayment schedules and other pitfalls that can lead to lost money.

Warning

Borrowers should not assume that lending institutions are acting in their best interests when offering loan agreements. For borrowers who cannot afford legal representation, the three areas where lenders can squeeze applicants for more money are late charges, grace periods and loan fees. These characteristics of loan agreements can lead to damaged credit and late fees for businesses that pay late in a single payment period. The lending market may not be hospitable for newcomers but borrowers with good credit should negotiate down late charges as well as application fees and ask for extended grace periods for monthly payments.

Features

Every loan agreement includes details on lending and payment schedules as well as penalties or fees applied for non-compliance by the borrower. The first section of the loan agreement features the amount of the loan, the number of months allowed to repay the principal and the interest rate applied by the lender. The second section may detail conditions for paying loans ahead of maturation dates, collateral information and rules for late fees. The final section of a loan agreement lays out default information and asks for signatures from a representative of the lender, the borrower and a cosigner if necessary.

Function

Loan agreements protect lenders against lack of repayment and detail the rights of borrowers during the life of the loan. Without a loan agreement, a bank would be stuck with thousands of dollars in debt, as well as attorney and processing costs in case of default. The interest rates, application fees and other expenses outlined in the loan agreement allows the lending institution to offer enough money to keep loans flowing to other applicants. While agreements are created by lending institutions, they also offer consumers information on their state and federal rights as borrowers. In states with consumer-friendly lending laws, loan agreements may be several pages long to account for consumer protection disclosures.

Effects

The repayment schedule in a loan agreement creates an atmosphere of trust between lenders and borrowers. A borrower who knows the monthly payments, final payment date and fixed interest rate on his loan will be able to budget accordingly. If the borrower is responsible in meeting payment obligations, the lender is more inclined to provide additional loans to the borrower in the future. The default and late fee provisions in loan agreements, in turn, allow lenders recourse against irresponsible borrowers without incurring unnecessary expenses. Growing banks and lending institutions can offer higher loan amounts to reliable borrowers by weeding out financially unstable applicants scared away by default provisions.

Considerations

Borrowers should look at their credit reports and assets before entering into loan agreements. Every lending institution looks at reports from credit reporting agencies to determine a loan applicant's financial stability. It is important for commercial borrowers to look beyond the free credit reports offered to individuals and find credit reporting agencies used by lenders. Some borrowers will need to put up homes, vehicles and equipment as collateral for large loans if they lack sufficient financial reserves. Each asset considered as collateral on a loan agreement should be evaluated by an independent auditor to help the lender determine if it is sufficient for the loan size.

Resources

• Kinsey Law Offices sample loan agreement
• LawDepot.com loan agreement creator