When to Use

  • Money or property is being loaned to one or more borrowers and you want an agreement to protect the lender and clearly define all the terms of repayment.
  • You want to be guided through all the typical loan options, such as payment frequency, interest, collateral, prepayment, co-signers, and personal recourse.

Other Names for This Document

  • Personal loan contract
  • Business loan agreement
  • Money lending contract
  • IOU or “I Owe You” agreement

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Help Guide

A loan agreement specifies all of the important terms and conditions for repayment of a loan. The loan that the lender provides to the borrower may be in the form of money or property, and you can choose to include multiple borrowers, lenders, and guarantors depending on the requirements of the transaction. The information below will guide you through some of the important issues and considerations you will encounter when creating your loan agreement.

Party Information

You will begin by entering the name and address of each borrower and lender. If a party is a business, be sure to include the full legal name of that entity, such as "eDemand, Inc.". If you include multiple borrowers, each borrower will be "jointly and severally liable" under the agreement. This is legal speak that means each borrower will be required to repay the full amount of the loan should another borrower default on its obligation. However, if a borrower is ever forced to pay back part of another borrower's portion of the loan, often that borrower will be able to then obtain a judgment in court against the defaulting borrower for the money it is owed. Joint and several liability will also apply if you choose to include one or more guarantors, discussed below.

Transaction Details

Next you will enter the details of the transaction. Be as specific as possible in describing what the borrower is receiving from the lender, whether it is a mortgage loan, goods, services, etc. You will then describe how the lender expects to be repaid. You will also have the option to include miscellaneous terms and conditions later in the document should you need to further customize your agreement.

Collateral

Answer whether or not the lender requires any collateral to ensure repayment. For example, in a mortgage agreement the collateral is the house itself. However, collateral is often other types of property, such as the borrower's inventory, real estate, or accounts payable. If the borrower defaults on repayment, the lender gets to keep or sell the collateral.

Prepayment

Prepayment refers to the borrower's ability to repay the loan ahead of schedule. Often, borrowers are prohibited from, or receiving a fee for, making prepayments because it prevents the lender from receiving steady payments and collecting a predictable amount of interest on the loan. If you choose to allow prepayment, you can then choose to require a prepayment fee for a percentage of the amount of the principal prepaid.

Notary and Witness

Lastly, you will be asked whether or not you want to include spaces for a notary and/or witness to sign. It is always recommended to include a notary to help prove the validity of the document should there ever be a question. For the same reason, including a witness is helpful. If possible, it is a good idea to include both.

Guarantor

Here you have the option to include one or more guarantors to guarantee the repayment of the loan should a borrower be unable to pay part or all of the outstanding debt. A separate guarantee agreement will automatically be included for each guarantor to sign along with the lender(s) and any notary or witness included.

As discussed above, each guarantor will be jointly and severally liable with each borrower and with each other guarantor for the full repayment of the loan. This helps assure that the lender will be repaid first and in full, and then the other parties can sort out how much they owe each other after the fact should the need arise.

Executing Your Loan Agreement

After you are done filling out the form, simply have the borrower, lender, and any notary and witness available sign the document. Again, although a notary and witness are not required in most jurisdictions, it is always a good idea to include them. When the document has been signed and witnessed, you are done! Make sure each borrower, lender, and guarantor (if any) each get a copy.

Frequently Asked Questions

Are there different types of loan agreements?

Yes. Loan agreements can range from simple promissory notes to complex loans like mortgages and auto loan agreements.

Loan agreements are governed by state and federal laws, which provide limits on the amount of interest lenders can charge when loaning money. Those laws also provide a framework and guardrails for other terms and conditions of loan agreements, designed to protect both the lender and the borrower in the event the agreement is later taken to court.

How do I create a loan agreement?

To create a loan agreement, you will need to gather some basic information about the lender(s), borrower(s), and co-signer(s), if applicable. You will also need to be prepared to answer questions about the amount borrowed, the term (length of time) for the loan, the interest rate and how interest is calculated and accrued, any collateral being pledged as security, and any other terms you want to include in the document.

All parties to a loan agreement should have an opportunity to read, review, and discuss the provisions included in the document before signing. After the loan agreement has been signed, all parties should retain copies of it for their records.

Creating a loan agreement through LegalNature is fast and easy. By following the step-by-step process and answering questions about the loan, our loan agreement allows you to quickly customize, review, and download a legally enforceable loan agreement in minutes.

Why should I create a loan agreement?

A loan agreement is important whenever a person or business is borrowing money from another person or business. The agreement spells out the amount borrowed and the terms for repaying the loan.

In the event the borrower does not uphold its end of the agreement, valid loan agreements can be enforced. This protects the lender.

However, loan agreements can also protect the borrower by making the terms clear. For example, a lender that tries to charge more interest or accelerate repayment in violation of what the loan allows could be forced by the court system to stick to the agreement’s original terms.

Finally, loan agreements also provide evidence that the money the borrower received was in fact a loan and not a gift.

What should I include in a loan agreement?

Loan agreements document the terms of a loan between a lender and a borrower (or many borrowers and lenders), including all of the rights, duties, and responsibilities of the parties.

It is important to make sure that your loan agreement includes, at a minimum, the following information:

  • Name and contact information of each lender
  • Name and contact information of each borrower
  • Name and contact information of the co-signer or guarantor (if applicable)
  • The amount borrowed
  • Whether there is collateral offered as a guarantee for the loan and, if so, a description of the collateral
  • The interest rate for the loan and whether it is a simple interest calculation or a compound interest calculation
  • Whether the interest rate is fixed or variable (if variable, the agreement should specify what the rate’s variability is tied to)
  • The amount to be repaid
  • The terms of repayment (i.e. number of payments/number of years)
  • Whether there are penalties for early payment under certain circumstances and, if so, how those prepayment fees are calculated
  • Whether the lender reserves the right to demand payment in full under certain circumstances
  • Whether the loan includes personal recourse provisions
  • The consequences of making late payments (i.e. the amount or percentage of late fees that will be added to the amount due)
  • The lender’s recourse if the borrower defaults on the loan and what legal damages are available to the lender in the event of a default, including who is responsible for paying the legal fees and expenses to enforce performance
  • The choice of law to document the parties’ agreement about what state or territory’s laws will govern interpretation and performance of the agreement
  • An arbitration provision requiring the parties to submit to, and agree to, binding arbitration instead of litigating disputes.

What are prepayment fees?

Some loan agreements include prepayment penalties (also called prepayment fees).

Prepayment fees state that if the borrower repays the loan before it is due, under certain circumstances the lender can charge an additional fee. These fees are designed to protect lenders who could lose out on the interest payments they would have otherwise been entitled to receive over time had the borrower not repaid early.

Prepayment penalties can be expressed as a fixed dollar amount or as a percentage of the remaining balance due at the time the loan is repaid in full (and ahead of schedule). These provisions can vary widely from lender to lender, with some lenders including prepayment penalties if the loan is repaid within a certain time period. Once that time period has passed, the borrower is free to pay the loan in full without penalty, even if it means the loan will be paid off early.

Borrowers should understand whether their loan agreement includes prepayment penalties and, if so, how and when those fees can be triggered.

Why are separate security agreements used?

When a loan agreement requires the borrower to pledge collateral for the loan, the lender may also require the borrower to sign a separate security agreement.

The security agreement provides the lender with a legal interest in the collateral being used for the loan, helping to mitigate the lender’s risk. Separate security agreements define and establish lenders’ rights in pledged collateral.

Sometimes the provisions regarding collateral are simply included in the loan agreement rather than in a separate security agreement.

What is the difference between compound and simple interest?

When it comes to the amount of interest on a loan, the loan agreement should spell out whether the interest is simple or compound.

Simple Interest

Agreements that use a simple interest formula multiply the interest rate by the principal amount of the loan to calculate the fixed amount of interest to be paid along with the principal amount borrowed. Simple interest is only calculated on the principal amount of the loan.

For example, a $10,000 loan with a 7% simple interest rate would require the borrower to pay $700 in interest ($10,000 x .07 = $700). If the loan is going to be repaid over a period of three years, you will need to multiply the amount of simple interest by three, giving you a total of $2,100 in interest to pay.

In summary, the borrower would be getting $10,000 up front and would have to agree to repay a total of $12,100 over the three years ($10,000 + $2,100).

Compound Interest

With a compound interest calculation, the compound interest accrues on the amount of the unpaid loan principal and accumulated interest from previous periods. So, when a borrower agrees to compound interest, they are in effect paying interest on the interest.

Where the amount of interest on a simple interest loan is the same from year to year, the amount of interest paid on a compound interest loan will vary from time period to time period.

Generally speaking, the borrower will pay more over the life of the loan to borrow money under a compound interest loan than they would for a simple interest loan.

What is a personal recourse provision?

It is common for loan agreements and security agreements to include personal recourse provisions.

Personal recourse provisions in loan documents state that, if the borrower defaults on its loan payments and if any pledged collateral is insufficient to repay the outstanding principal and interest amount still owed on the loan, then the lender can hold the borrower personally responsible for the payment.

This means that the borrower’s personal assets, including bank accounts, investments, and wages, could be at risk in the event of a default.

However, just because a loan does not include a personal recourse provision, it does not mean that the borrower will not be held personally responsible for repayment. For example, in the event of borrower fraud, state law may allow the lender to go after the borrower regardless of whether the loan agreement includes a personal recourse provision.

What is a "due on demand" payment?

If a loan agreement or a promissory note includes a “due on demand” provision, it means that the lender has the right to demand payment in full at any time if certain conditions are met. Essentially, due on demand agreements put the control squarely in the lender’s hands.

For example, many due on demand clauses say that if the borrower defaults on its obligations under the agreement, the lender can demand immediate payment in full.

What is collateral and should I include it in my loan agreement?

If a loan agreement includes collateral, it means that the borrower has agreed to pledge certain assets as security for the loan. In the event the borrower defaults and does not uphold his or her agreement to repay the loan amount plus interest, the lender gets to keep the pledged collateral. Loans that use collateral are often referred to as “secured loans.”

In theory, almost any asset can be used as collateral. However, in practice, most lenders will only want collateral that they could actually use or sell in the event the borrower defaulted on the loan.

When you buy a home, your house is the collateral for a home mortgage. Similarly, auto loans are secured by the vehicle itself. Personal loans may be secured by stocks or bonds, bank accounts, insurance policies, machines or equipment, collectibles, future payments from the borrower’s customers (accounts receivable), or by other financial asset(s).

Generally speaking, pledging collateral for a loan can be advantageous to the borrower because the lender may be willing to offer a lower interest rate or loan a larger dollar amount. The lender’s risk of loss is lower because it knows it can keep the borrower’s collateral in the event of a default.

Borrowers should make sure they will be able to adhere to the terms of the loan agreement so they do not risk losing their pledged assets.

What is the difference between fixed and variable rates of interest?

Loan agreements should specify whether the interest rate the borrower is agreeing to is fixed or variable.

When a loan agreement uses a fixed interest rate, the interest rate will not go up or down over the life of the loan. This allows for a defined, fixed payment schedule and can be attractive to borrowers who want to know that their monthly payments will be fixed.

In contrast, when a loan agreement uses a variable interest rate, that rate will likely change during the term of the loan. When loans are based on variable interest rates, those rates are generally tied to either the prime lending rate or an index. Variable rate loans can be advantageous for borrowers when interest rates go down. However, if the rate rises, the borrower will still need to be able to make his or her payments under the agreement.

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Checklist

Step 1: Gather Information

As you complete your loan agreement, you will need to provide certain relevant information. This includes the names and addresses of all borrowers and lenders, transaction details, and repayment terms.

Step 2: Answer Key Questions

Use the information you collected to complete the loan agreement. We make this easy by guiding you each step of the way and helping you to customize your document to match your specific needs. The questions and information we present to you dynamically change depending on your answers and the state selected.

Step 3: Review and Sign

It is always important to read your document thoroughly to ensure it matches your needs and is free of errors and omissions. After completing the questionnaire, you can make textual changes to your document by downloading it in Microsoft Word. If no changes are needed, you can simply download the PDF version and sign. These downloads are available by navigating to the Documents section of your account dashboard.

Although a notary and witness are not required in most jurisdictions, it is always a good idea to include them. When signing the document, be sure to follow any additional instructions related to signing and witnessing the document. Any such instructions will either be located next to the signature line or in the instructions attached at the end of the document.

When using a notary or other witness, you must wait to sign the document until they are present.

Step 4: Distribute and Store Copies

At a minimum, all parties that sign the document should receive a copy once it is fully executed (everyone has signed). Other interested parties may need or want copies as well. Be sure to store your copy in a safe location. It is a good idea to keep both a physical and electronic copy.

Step 5: Periodically Review and Update

It is easy to forget the ins and outs of your loan agreement. Periodically reviewing it will help you stay familiar with any responsibilities or requirements so that you can determine when it needs changes or additions.

Step 6: Complete Related Documents

Completing documents such as a promissory note and sales contract may help offer additional protection. For example, a promissory note holds the buyer responsible for repayment. A sales contract, if applicable, will help solidify terms regarding delivery, shipment instructions, warranties, and important deadlines.