What Does It Mean to Draft a Loan Agreement?
If you are a lender or want to give someone a personal loan, drafting a loan agreement can formalize the arrangement. Loan agreements are binding contracts between a borrower and lender that cover details, terms and conditions, and repayment schedules in the repayment agreement.
Borrowing a loan can help you, from starting a business to buying a house, but the lender takes a risk whenever they give someone money. To not only recoup their loss but financially profit from the loan, they’ll need a loan agreement that includes a reasonable agreed-upon interest rate.
Drafting a loan agreement allows you to loan someone money while legally enforcing their obligation to repay you. Without a loan agreement, there is no way to take someone to court for borrowing money and not paying it back, even if they said they would.
Here is an article that defines loan agreements.
Types of Loans
A loan is borrowing money and repaying it over time, usually with interest. But not all loans are the same, and the loan type you borrow will affect when you pay it back, how you make repayments, and how much you’ll owe at the end of the agreement.
Below are four of the most common loan structures.
Unsecured Conventional Loan
Unsecured conventional loans do not require any collateral to borrow. Collateral is assets you put forth as a show of good faith, which the lender can claim if you fail to pay back your debt. Common collateral includes:
- Real estate
- Investments
- Blanket liens
An unsecured loan relies on creditworthiness for approval. If someone’s credit score is too low or they do not have a credit history, they will not be approved for this type of loan.
Secured Conventional Loan
Secured conventional loans require collateral to protect the lender’s investment in the borrower. Suppose a borrower doesn’t pay back what they owe. In that case, the lender has the legal right to seize the collateral offered in the initial loan agreement and recover their financial losses.
Opened-Ended Loan
Open-ended loans are pre-approved, similar to credit cards, and allow the borrower to withdraw funds gradually at their discretion. So, rather than be given a lump sum of cash at once, you are approved to borrow a certain amount. This flexible type of loan lets borrowers take out and repay their loans incrementally.
Open-ended loans are also known as lines of credit because they give someone access to a set amount of money they can borrow as needed. The limits, terms of repayment, and interest rate will all vary by lender and borrower.
Closed-Ended Loan
Closed-ended loans have a fixed amount of money a person can borrow, which must be repaid at the end of the payment agreement. You are given a set amount of time to repay what you’ve borrowed and any interest.
Close-ended loans can be personal cash, auto, or home mortgages.
Here is an article with 17 different types of personal loans to know about.
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Who Can Draft a Loan Agreement?
You can write your loan agreement or have a lawyer draft the loan agreement for you. A handwritten loan agreement is legally binding as long as it meets your state's legal contracts requirements.
All legal contracts must be signed mutually and without coercion or stress. In addition, the contract cannot be unconscionable, meaning it is extremely favorable to one party or deliberately undermines or exploits another.
Drafting a loan agreement can be as simple as posting a project on ContractsCounsel’s marketplace. You’ll receive personalized bids from licensed attorneys to write your contract for a flat fee.
You can also explore online loan agreement templates to understand better what your document should look like. You should submit a template to a lawyer for review if you decide to use a template. Even if a legal template seems valid, it may not contain the necessary provisions your state requires.
You can also have a borrower sign a promissory note. This document contains a promise to repay their debt for a specific date. Promissory notes are used in place of loan agreements.
Here is an article with a guide to promissory notes.
What Should Be Included in a Loan Agreement?
Every loan agreement needs the following elements:
1 . Lender and Borrower Information. You should begin the agreement by identifying the borrower and lender by their legal names.
2. Type of Loan, Loan Amount, and Issue Date. The loan agreement's introduction should describe the loan type the borrower is requesting, how much money it will be offered, and the date the loan goes into effect.
3. Terms and Conditions. Any and all relevant terms and conditions relating to the loan, repayment, and interest should be outlined. You may also attach a collateral loan agreement or convertible loan agreement. Ensure your agreement clarifies how much the borrower has been given and how much they owe at the end of the loan term (principal balance plus all interest).
4. Deadline. Establishing a deadline for the borrower to make repayments is crucial, even if they have an open-end loan. While their line of credit can remain open, they must still have deadlines to make payments and fully pay off any borrowed amounts.
5. Consequences of Non-payment. Be sure to include the penalties for non-payment and procedures the lender will take in order. For example, failure to miss a payment deadline may start with a written notice to pay, followed by legal action.
6. Statement of Agreement. The loan contract must have a statement of agreement acknowledging that both parties agree to the terms. It can be as simple as, “By signing this document, both the lender and borrower acknowledge and agree to the terms and conditions of this agreement.”
7. Signatures and Dates. Both parties should sign and date the agreement before any loan money is dispersed. Dates are especially important as loan agreements tend to focus on deadlines for repayment. Without a date, it can be difficult for the court to determine when a borrower was legally obligated to repay their loan.
Here is an article with ContractsCounsel’s guide on how to write a loan contract in 6 steps.
What is the Purpose of a Loan Agreement?
The purpose of a loan agreement is to legally force the borrower to repay the money they owe the lender. Without a written loan agreement or promissory note, it can be difficult for the lender to hold the borrower accountable for payment.
Loan agreements can protect borrowers, too. By listing the terms of the loan and an agreed-upon interest rate, you can prevent yourself from being exploited and having the lender change the terms or rate of your loan at will.
Here is an article with the seven most important terms to include in any loan agreement.
What is the Difference Between a Loan Agreement and a Mortgage?
A loan agreement can apply to any type of personal, business, or home loan. For example, a mortgage is a loan someone borrows to purchase real estate, like a house or commercial property, for their business.
Loan agreements are a part of any mortgage; the borrower agrees to repay the lender over a fixed period of time for a certain amount. Interest rates can be fixed or variable, depending on the mortgage you borrow.
Here is an article with information from the Consumer Protection Financial Bureau about how mortgages work.
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