A loan agreement is a formal written contract used whenever money is borrowed. The contract defines who the borrower and lender are, the amount of money lent, the interest rate, and how long the borrower has to pay it back. The primary purpose of the contract is to protect the lender should the borrower not uphold their commitments.
Auto Loan Agreement – For loaning money to a person or business for the purchase of a motor vehicle.
Business Loan Agreement – Used for establishing the terms and conditions for money lent to a company.
Employee Loan Agreement – Used when a company lends money to one of their employees.
Family Loan Agreement – A lending contract formed between two (2) or more family members.
I Owe You (IOU) Agreement – An informal agreement that recognizes money was lent from one entity or person to another.
Loan Extension Agreement – For skipping a certain number of loan payments. Interest still accrues during the interim.
Payment Plan Agreement – Used for structuring the payment timeline a borrower will be required to follow when repaying a loan.
Personal Loan Agreement – A general agreement used for lending money for a wide range of needs, such as a wedding, home renovation, or a vacation.
Promissory Note – A middle-of-the ground between a loan agreement and an IOU. Serves as an official “promise” to pay the lender the borrowed money.
Simple (1 page) Loan Agreement – A one (1) page loan agreement that remains fully useable and legally binding despite it’s short length.
Definition: A written contract that provides verifiable proof that money was loaned from one entity to another.
A loan agreement is a document used to structure the terms and conditions of lent money. It establishes when (and for how long) the borrower needs to make payments on the loan. The contract can be used for principal-only loans (no interest) and many other types of lending.
While the loan process is similar from one type to the next, the financial institution you contact for a quote will vary based on your needs. The types of loans are endless, but many fall into the major categories below:
|Loan Type||Avg. Interest Rate||Avg. Term Range|
|Personal Loans||9.41% (Source)||1-5 years (Source)|
|SBA (Business) Loans||5.5-8% (Source)||5-25 years (Source)|
|Student Loans||5.8% (Source)||10-20 years|
|Auto Loans||5.61-9.65% (Source)||6 years (Source)|
|Mortgage (Home) Loans||3.21% (Source)||15-30 years|
|Payday Loans||391% (Source)||~ 2 weeks (Source)|
Check your Credit Score
Before shopping around for quotes, the borrower should get an idea of how their financial resume looks in the eyes of lenders. The majority of one’s financial history is found in a credit report. This is a report that lenders request from consumer reporting agencies to get an idea if it’s worth lending to you. To get an idea of where your credit sits, you can obtain a free report from AnnualCreditReport.com (the only website authorized by the FTC for obtaining free reports). Unlike the hard inquiries that are run when you apply for credit, obtaining your own credit report does not impact your credit score.
If you find anything that is incorrect in the report, you’ll need to contact all three (3) reporting agencies to have it corrected. The overall health of your report will greatly impact whether you are accepted for a loan, as well as the terms you receive. The majority of lenders will deny an application if your score is under a certain level. If you’re currently holding too much debt or your score is impacted by previous bankruptcies, missed payments, and so on, it may be in your best interest to work on your credit before applying.
There are several types of lenders that offer loans. These include:
- Credit unions;
- Mortgage lenders;
- Peer-to-peer lenders; and
- Online lenders.
The most common types of lenders for personal loans are banks and credit unions. When looking for a loan, an important takeaway is to never settle for the first lender. Unless you’re certain the rate is fair (or you have no other options), it pays to shop around to get an idea of what other lenders charge.
When shopping for a loan, try and get the quotes within a 30-45 day span. This is because the majority of lenders will run a hard check on your credit to determine your rate (which will chip away at your credit score). By receiving multiple rates in a specific time period, the checks can appear as a single grouped credit check.
Once a suitable lender has been found, the borrower will need to submit an application. The application process is unique to each lender – some permit online applications in addition to in-person apps. The information that is generally required in an application includes:
- Full name;
- Mailing address;
- Employer; and
- Your reason for the loan.
Including the reason for requesting the loan is important, as the lender will often customize the loan to your exact needs (which can often result in paying a lesser interest rate).
After the application process has started, the lender will require further documentation to prove your identity and financial standing. This may include some (or all) of the following:
- Pay stubs from the past thirty (30) days;
- W2 forms;
- Bank statements;
- Tax returns;
- Social Security Number (SSN); and
- Proof of identity (ex: driver’s license).
The loan could be approved in as little as seventy-two (72) hours. Before receiving the money, the borrower will need to finalize the loan process by accepting the terms and signing the loan agreement.
Once the agreement has been signed, the money should arrive between one (1) to fourteen (14) days. Once in possession of the money, the borrower will need to make consistent payments on a weekly or monthly basis. The agreement should contain all of the details regarding payment, including how interest and principal are distributed in each payment, ways the borrower can pay (online, for example), and the date of the last payment.
What variables affect the loan interest rate?
The most common borrower variables that affect the interest rate they’ll receive for a loan include:
- Credit score (most important);
- Loan term and principal;
- Outstanding debt;
- Purpose of the loan; and
- Collateral (if an unsecured loan).
What is a Home Equity Loan?
A home equity loan is a loan that is secured by a person’s home. More specifically, it’s covered by the home’s value, minus the mortgage currently owed. The common rate banks will offer is 85% of the home’s value.
|Home equity loan example:|
Step 1: Calculate the maximum amount that could be borrowed:
$300,000 * .85 = $255,000
Step 2: Subtract the total borrowable amount by the current mortgage:
$255,000 – $225,000 = $30,000
What is a Payday Loan?
Payday loans are a type of personal loan that often need to be repaid by the borrower’s next payday (2-4 weeks after taking out the loan). They’re notorious for their short-term nature and high interest rates. Due to the sometimes predatory nature of the loan type, state governments have started to regulate the terms that can be offered to borrowers.
Payday vs. Cash Advance?
While both a payday loan and cash advance are short-term, highly expensive ways of borrowing money, they differ in that a cash advance is a loan obtained from one’s credit card (usually through an ATM or bank), whereas a payday loan is obtained through a standalone lender. Additionally, the terms of a cash advance often involve an upfront fee (up to 8% of the advance) and interest that begins accruing immediately. The terms of a payday loan are based upon fees – ranging from $10-30 per every $100 borrowed. If the borrower doesn’t pay off the loan by the due date, they are charged additional fees that tack-on to the total amount owed.
What if the borrower dies before paying off the loan?
When a person dies while owing money on an unsecured loan, the lender will often file a claim against the estate to receive payment. Should the estate not have the capital to pay off the debt, the person handling the estate (the “executor”) is required to sell the estate’s assets until the debt can be repaid. If the estate’s assets still cannot repay the loan in full, the lender will need to write off the amount.
Step 1 – Loan Overview
In the box at the top of the agreement, write the loan amount. The first field is for writing the loan amount with numbers (ex: “$2,000.00”), and the second field is for writing the amount out with words (ex: “Two-thousand dollars”). Beneath the amount, write the date the agreement is being filled out (most likely today’s date).
Step 2 – Borrower & Lender
In the section titled “The Parties”, the following information will need to be written:
- Full name of the borrower
- Borrower’s mailing address
- Full name of the lender (can be a company or a person’s name)
- Mailing address of the lender
Step 3 – Payment
There are four (4) payment options listed, with the last allowing you to write your own payment terms. Select one of the four by placing a checkmark in the appropriate box.
- If you selected “Weekly payment”, write the amount ($) the borrower needs to pay each week, followed by the date of the first payment, and finally the date in which the last payment will be due.
- If you selected “Monthly payment”, write the amount ($) the borrower will need to pay on a monthly basis, followed by the day, month, and year of the first payment, the day of the month in which payments will be due (ex: “1st”), and the full date in which the last payment will be due.
- If “Lump sum” was selected, write the full amount of money the borrower will need to pay (including interest, if applicable), followed by the day, month, and year in which the payment will need to be made.
- Finally, if “Other” was selected, write your own terms. Be sure to include the amount the borrower will need to pay and when they need to go about paying it.
Step 4 – Interest
If the loan will accrue interest, check the first box and enter the rate in words (ex: “three-percent”) followed by the rate numerically (ex: “3.0%”). If interest will not be charged, check the second box.
Step 5 – State Name
At the top of the last page, write the name of the state in which the maximum usury rate was referenced. This should be the state in which the parties are based. Under “Governing Law”, write the name of the state in which state law will apply. This should be the same state that was written for the usury rate.
Step 6 – Signatures
At a minimum, the agreement needs to contain the signatures of the borrower and the lender. However, witness fields have been included if the parties would like additional proof that they signed the document. Each party will need to write:
- Their signature (by-hand or with eSign);
- The date (mm/dd/yyyy) they signed their name; and
- Their printed name.