A loan agreement is a very complex document that can protect the two parties involved. In most cases the lender creates the loan agreement, which means the burden of including all of the terms for the agreement falls on the lending party. Unless you have created loan agreements before, you will likely want to make sure that you completely understand all of the components so you do not leave out anything that can protect you during the lifetime of the loan. This guide can help you create a solid loan agreement and understand more about the mechanics behind it.
Before you lend anyone any money or provide services without payment, it is important to know if you need to have a loan agreement in place to protect you. You never really want to loan out any money, goods, or services without having a loan agreement in place to ensure that you will be repaid or that you can take legal action in order to have your money recouped. The purpose of a loan agreement is to detail what is being loaned and when the borrower has to pay it back as well as how. The loan agreement has specific terms that detail exactly what is given and what is expected in return. Once it has been executed, it is essentially a promise to pay from the lender to the borrower.
Borrowing money is a big commitment no matter the amount, which is why it is important to protect both parties with a loan agreement in place. A loan agreement not only details the terms of the loan, but it also serves as proof that the money, goods, or services were not a gift to the borrower. That is important because it prevents someone from trying to get out of repayment by claiming this, but it can also help you ensure that it is not an issue with the IRS later. Even if you think you may not need a loan agreement with a friend or family member, it is always a good idea to have this in place just to make sure there are no issues or disagreements over the terms later that could ruin a valuable relationship.
If you are trying to determine whether you need a loan agreement, it is always better to be on the safe side and have one drafted. If it is a large sum of money that will be repaid to you, as agreed upon by both parties, then taking the extra steps to ensure that the repayment takes place is well worth your time. A loan agreement is designed to protect you so when in doubt, create a loan agreement and make sure you are protected no matter what happens.
There are several components of a loan agreement that you will need to include in order to make it enforceable. These are a few of those components that are true no matter what type of loan agreement it is. To help explain how a loan agreement is broken down, we have divided it into sections that are easier to comprehend.
With every loan agreement, you need to have some basic information that is used to identify the parties that are agreeing to the terms. You will have a section that details who the borrower is and who the lender is. In the borrower's section, you will need to include all of the borrower's information. If they are an individual, this includes their full legal name. If they are not an individual but a business, you will need to include the business or entity designation, which must include "LLC" or "Inc." in the name in order to provide detailed information. You will also need to include their full address. If there is more than one borrower, you should include the information of both on the loan agreement. The lender, sometimes also called the holder, is the person or business that will be providing the goods, money, or services to the borrower once the agreement has been agreed to and signed. Just like you included the borrower's information, you will need to include the lender's information with just as much detail.
Additionally, you will need to include a section that details any guarantor information, if you have one. A guarantor is also known as a cosigner. This individual or business agrees to pay back the loan in the case that the borrower defaults. You can add more than one guarantor to the loan agreement, but they must agree to all terms set forth in the loan just like the borrower. Just like you included the borrower's information, you will need to include the information of each guarantor, and they must sign the agreement. You will need to include their full legal name as well as their full address. If you do not include a guarantor, you will not need to include this section as part of the loan agreement. Lastly, you will need to include a section that includes the date and location of the signing of the agreement. In this section of the loan agreement, you will need to include various information such as the date the agreement is effective, the state where any legal proceedings are required to take place, and the specific county within that state. This is important because it details when the loan agreement is active and will prevent you from having to travel to another place if there are any disputes or nonpayment on the agreement.
Once you have the information about the people involved in the loan agreement, you will need to outline the specifics surrounding the loan including the transaction information, payment information, and interest information. In the transaction section, you will detail the exact amount that will be owed to the lender once the agreement has been executed. The amount will not include any interest that will accrue during the lifetime of the loan. You will also detail what the borrower is getting in return for this sum of money that they are promising to pay to the lender. In the payment section, you will detail how the loan amount will be repaid, the frequency of the payments (e.g. monthly payments, due on demand, one lump sum, etc.), and information on the acceptable payment methods (e.g. cash, credit card, money order, wire transfer, debit payments, etc.). You will need to include exactly what you will accept as a form of payment so there is no question on the forms of payment allowed.
In the interest section, you will include information for any interest. If you are not charging interest, then you will not need to include this section. However, if you are, you will need to detail the date when the interest on the loan will begin to accrue and whether the interest will be simple or compound in nature. Simple interest is calculated on the unpaid principal amount while compound interest is calculated on the unpaid principal and any interest that is unpaid. Another aspect of interest you will need to detail is if you will have a fixed or variable rate of interest. A fixed rate interest loan means that the interest rate will stay the same during the lifetime of the loan, whereas a variable rate loan means that the interest rate can change over time based on certain factors or events.
You may also want to include information about prepayment in case the borrower is interested in paying the loan off early. Many borrowers are concerned about prepayment and you would be wise to include a clause in your loan agreement that talks about prepayment options, if any. If you are allowing prepayment, you will need to include this information and detail if they are allowed to prepay the entire amount or only a partial amount, and if you will be requiring a prepayment fee if they choose to do so. If you are requiring a prepayment fee, you will need to detail how much that will be. Traditionally, lenders require that a percentage of the principal is paid early before they can pay the remaining balance. If you are not allowing prepayment, then you will need to detail that it is not allowed unless written permission is provided by you, the lender.
You have the option of requiring collateral in exchange for your loan. If you wish to do this, then you need to make sure you include sections that address this. For collateral, if you are requiring it to secure the loan, you will need to have a specific section. Collateral would be an asset that is used as a guarantee of repayment. Examples of assets that can be used include real estate, vehicles, or other valuable goods. If you are requiring collateral, you will need to identify all collateral that is needed to secure the agreement. Another section you need for this is one regarding the security agreement. If you are not requiring collateral, then you can omit this from your loan agreement.
In regard to the collateral, if each party is signing a separate security agreement for it, then you will need to include the date that the security agreement is signed, or will be signed, by each party.
No one ever thinks that the loan agreement they have will be violated, but if you want to make sure that you can deal with the matter in case the terms are not followed, then you need to have something addressing it. This is just one reason why it is so important to include this section no matter what. Typically, lenders include a personal recourse provision. This will allow the lender to seek recovery from the personal assets of the borrower if they violate the agreement. Additionally, you should include the number of days that the borrower has to remedy any breach of the agreement. If you include this, you cannot provide notice of recuperation until this time frame has passed. It does not, however, prevent you from reaching out to them for an update. The notice period that is standard is 30 days, but you can adjust this as you see fit. Make sure you include all of these details in this section so there is no question about the actions you should be taking in case you are not paid back by the borrower.
In addition to the main sections detailed above, you have the option of adding additional sections to address specific items as well as a section to make the validity of the document unquestionable. Every loan agreement is different, so use the additional terms and conditions section of the agreement to include any additional terms or conditions that have not yet been covered. In this section, you will need to include complete sentences and ensure that you do not counteract anything that has previously been put in the loan agreement unless you are stating that a specific section is not applicable to this specific loan agreement.
When executing your loan agreement, you may be interested in having a notary notarize it once all parties have signed, or you may want to include witnesses. The benefit of including a notary is that this will help prove the validity of the document in case it is ever disputed. Having a witness is an alternative to having the document notarized in case you do not have access to a notary; however, if possible, you should always try to include both.
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