What is a Loan Agreement?

how to write a loan contract

Loan contracts are binding agreements between one or more parties to formalize a loan process. There are many types of loan contracts. ranging from simple promissory notes between friends and family members to mortgage, auto. credit card and short- or long-term payday advance loans.

Each type of loan and its conditions for repayment are governed by both state and federal guidelines – ones that prevent illegal or excessive interest rate on repayment.

In addition, loan length and default terms should be clearly detailed to avoid confusion or potential legal court action.

In case of default, terms of collection of the outstanding debt should clearly specify the costs involved in collecting upon the debt.  This also applies to parties of promissory notes as well.

Purpose of a Loan Contract

All loan contracts should define clearly the purpose as well as the amount that is being loaned. There is no distinction made in law as to the type of loan made for a new home, a car, or how to pay off new or old debt how binding the term are.

The signed loan contract is proof that the borrower and the lender have a commitment that funds will be used for a specified purpose, how the loan will be paid back and at what amortization rate.

Contract Terms

Terms of the loan contract and which state or federal laws govern what the document performance obligations required by both parties are, will differ depending upon the loan type.

All loan agreements must specify general terms which define the legal obligations of each party. For instance, the terms regarding repayment schedule, default or contract breach, interest rate, loan security, as well as collateral offered must be clearly outlined.

Interest Rate Determination

Many borrowers in their first experience securing a loan for a new home, automobile or credit card are usually unfamiliar with loan interest rates and how they are determined. Simply put, depending upon the type of loan being requested, the borrower’s credit score and if the loan is secured or unsecured, an interest rate is determined for that loan.

In some cases, a lender will request that the loan interest paid be tied to material assets like a car title or property deed. State and federal consumer protection laws set legal limits regarding the amount of interest

a lender can legally set without it being considered an illegal and excessive usury amount.

Contract Length

The length of a loan contract is determined by a lender’s reliance upon an amortization schedule. Once the lender and the borrower have determined the amount of money needed, the lender will use the amortization table to calculate what the monthly payment will be by dividing the number of payments to be made and adding the interest onto the monthly payment.

Unless there are certain loan conditions that penalize the borrower for early loan payment, it is in the best interest of the borrower to pay back the loan as quickly as possible. The faster the loan debt is retired the less money will be owed on the loan.

Pre-Payment Fees and Penalties

While the goal to pay back a loan quickly is a financially sound practice, there are certain loans that penalize the borrower with pre-paid fees and penalties for doing so.

Pre-payment penalties are typically found in automobile loans or in mortgage subprime loans.

On the other side are homes financed through government-backed FHA loans. Federal law specifically forbids prepayment penalties on FHA loans. The exception is if the borrower has a mortgage that contains a due-on-sale clause and the clause has been allowed as part of the mortgage.

Breach or Default

If a loan contract is paid off late, the loan is considered in default. The borrower can be liable for a myriad of potential legal damages to compensate the lender for any losses suffered.

The breached, or defaulted, lender can pursue litigation and have a court hold the borrower for liable for legal costs, liquidated damages and even have assets and property attached or sold for repayment of the debt.

In addition, a breach or default of court judgment can be placed on the borrower’s credit record.

Usury and Predatory Protections

Several federal and state consumer protection laws protect consumers against predatory and usury loan tactics used by lenders.

Borrowers are federally protected by the Truth In Lending Act, Real Estate Settlement Act and the Home Owners Protection Act.

Many states enacted companion consumer predatory and usury protection acts to protect borrowers. Both parties benefit because lenders make reasonable interest repayment rates and borrowers receive a much needed loan.

Source: www.debt.org

Category: Credit

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