Loan contracts are written agreements between financial lenders and borrowers. 4 min read updated on February 01, 2023
What are Loan Contracts?
Loan contracts are written agreements between financial lenders and borrowers. Both parties sign the loan contract in writing in case one of the parties breaches the contract. This agreement states that the borrower will repay the loan and that the lender will give the borrower money.
Benefits of Loan Contracts
1. Verbal contracts may not be enforceable.
2. Loan contracts can detail the consequences of defaulting on the loan.
3. It documents the agreement for possible arbitration or mediation later.
4. It articulates the loan's payment schedule and interest rate.
Frequently Asked Questions About Loan Contracts
What information should I include in my loan contracts?
Loan contracts are used to establish the guidelines for the loan. Essentially, they set the terms of the agreement that both parties will abide by. You can often find terms such as an amortization table which establishes the monthly payment rates and interest for the loan.
Can I write my own loan contract if I am not fluent in legal speak?
Yes, you can write your own loan contracts. One of the best aspects of a loan contract is that it can be as complicated or simple as you make it. The key is to provide clear details so that the terms can be clearly understood. That does not mean that it has to be a long or complex contract.
How do I identify the parties involved in the loan contract?
At the beginning of the contract, the parties involved are clearly listed, and you identify what they will be called in the contract. For example, a lender can be called many things including an “issuer”, “maker”, “payee”, or “seller,” provided that you identify them that way at the beginning of the contract and continue to use the same name consistently throughout.
What is the simplest way to make a loan contract?
If you are looking for something simple, then you can opt to use a promissory note instead. It is a simpler form of a loan contract. The main differences are that the promissory note has simpler terms that do not need greater detail to understand and explain, and they are often only signed by the borrower (the party that is borrowing the money). If you are setting up a contract that is more complex and has terms that may be difficult to explain, then you will want to use a loan contract since they can be more complex, longer, and signed by both parties.
Won't setting up a loan contract make the borrower think that I don't trust him or her?
Setting up a loan contract does not mean that you don't trust someone. It simply gives you the tools that you need to make sure that everyone involved understands their part in the agreement and to protect yourself in case you need to take further action to collect money or protect your position. It is the same as having any other documentation that people use on a regular basis, like a driver's license or a passport.
This the first that I have heard of a loan contract. What if I borrowed money but filled out a different agreement?
If you borrowed or lent money in the past, then you likely have a loan contract. They are often referred to by different names based on where you take the loan. These names include:
- Business Loan Agreement
- Loan Contract
- Personal Loan
- Promise to Pay
- Secured/Unsecured Note
- Term Loan
In terms of interest, how do loan contracts with compound interest work?
Compound interest calculates interest based on the total amount (including the accumulated interest) that you owe. So, the borrower will pay interest on the amount of the loan that has not yet been paid plus that interest that is owed based on that original amount.
How to Write Loan Contracts
1. Create an agreement that details who agreed to loan money to whom on what terms. This should include:
- Borrower's information
- Lender's information
- Principal loan amount
- Interest rate
- Maturity date or when the loan will be repaid
2. Make sure to include payment terms and schedule.
- This may be monthly or weekly payments and/or the length of the contract.
3. List acceptable payment methods, such as a check, credit card, or cash, with an address the borrower can mail a payment to.
- If the loan has pre-payment penalties, it should be listed.
4. Clearly articulate what happens if the borrower makes late payments or misses one.
- This includes if collateral will be repossessed.
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