A loan agreement is a legally binding contract between a lender and a borrower that a court can enforce if one party doesn’t follow the arrangement. It establishes the amount the lender is lending and sets other terms, including the repayment schedule and interest.
Loan Agreements – By Type
When to Use a Loan Agreement
Use a written loan agreement whenever you lend or borrow money. Here are some situations where you may need to create this document:
- Starting a business with a capital loan [1]
- Purchasing land or a home with a real estate loan
- Investing in a college education or repaying a student loan
- Buying a new car or boat with a vehicle loan
- Getting a paycheck advance from an employer
- Helping a friend or family member with a personal loan
When making a loan agreement contract between family members, you should be aware that there can be tax implications. For example, if you lend money without interest, the IRS may charge you tax because it would be below the minimum interest rate required for family loans. This amount is the Applicable Federal Rate (AFR). [2]
Also, if you’re borrowing money from family or friends and don’t have to repay the loan, the IRS will consider this transaction a gift and charge you gift tax if the amount exceeds the yearly maximum. [3]
IMPORTANT
If you see an exorbitantly high interest rate on a potential loan agreement, you shouldn’t sign it without serious consideration. You may be a victim of a loan shark, which is a lender who preys on individuals and charges the highest legal interest rate possible.
How to Get a Loan
Step 1 – Decide on the Loan Type
Secured Loans: They require collateral as a precondition for borrowing, typically a home or vehicle.
- Auto Loans: Use to purchase a vehicle.
- Mortgage Loans: Use to buy a home.
- Personal Loans: Use to fulfill any personal needs you have.
Unsecured Loans: They don’t require collateral. A borrower promises to repay the amount via a contract.
Variable-Rate Loans: They have an interest rate that changes over time.
Fixed-Rate Loans: They have an interest rate that stays the same for their entire duration.
Payday Loans: They’re short-term and immediate loans with high interest rates.
Step 2 – Check Your Credit Score
Your credit score indicates how likely you are to repay a loan. Lenders consider this metric when assessing your loan application.
The higher your credit score, the better chance a lender will want to loan to you. You can obtain your credit score from one of the three major credit bureaus: Experian, Transunion, and Equifax. Once you learn your current credit score, you can understand which interest rates you may qualify for.
Step 3 – Compare Lenders
Shop around for the best personal loan option. Research and compare lenders based on interest rates, fees, repayment terms, and customer reviews.
You have several options to find personal loans:
- Banks could be the best option if you have a good to excellent credit score. They offer low interest rates, few fees, and flexible repayment terms.
- Credit unions offer loans to their members. They tend to have lower interest rates and fees and can’t charge more than 18% APR (annual percentage rate) on personal loans [4] .
- Online lenders let you prequalify, apply for, and receive personal loans online, but they have higher APRs and fees than banks and credit unions.
Consider obtaining a loan from a family member or friend who has extra money to lend. Even if you know the lender well, it’s still a good idea to get a personal loan agreement in writing.
Step 4 – Gather Necessary Documents
Lenders may request several documents to verify your information. Gather them in advance so you can present them when lenders request them. Examples of these documents include proof of identity (like a driver’s license or an affidavit of identity), proof of income, bank statements, and rental or mortgage agreements.
Step 5 – Get Prequalified for a Loan
Many lenders offer a prequalification process involving a soft credit check that estimates the loan amount and interest rate you might qualify for. Thanks to prequalification, you can preview the potential offers you may get from lenders and narrow them down based on potential interest rates, fees, terms, and amounts.
Note that the prequalification process doesn’t guarantee you’ll get a loan. It also doesn’t require you to accept one.
Step 6 – Start the Application Process
If you’re satisfied with the prequalification terms, pick one that matches your needs and proceed with the formal loan application. Complete the lender’s application form with accurate information, finalize the documents, and accept the terms.
Step 7 – Accept the Loan
If you receive loan offers after applying, review them carefully. Pay attention to the loan amount, interest rate, repayment term, and associated fees, and read and understand the fine print. If all the details meet your needs, you can accept the offer and sign the loan agreement.
How to Notarize a Loan Agreement
Follow these steps to notarize a loan agreement:
- Find a notary public. You can find a certified notary public at a local accountant’s office, lawyer’s office, bank, or public library. You may also use free online services to connect with a notary public who isn’t in your area.
- Schedule a meeting with the notary public. Schedule a meeting with them. The other party (whether they’re the borrower or lender) can be present, but they may also have their signature notarized at a different time.
- Meet with them. Meet with the notary public. Present a valid form of government-issued ID so they can confirm your identity.
- Sign the agreement. Sign the agreement in front of the notary public. Once you both sign, they’ll add their seal to your document.
- Pay the associated fee. Pay the nominal fee for the notary public’s services. Depending on where you live, you may expect to pay between a couple of dollars and $10.
Do I Need to Get a Loan Agreement Notarized?
While most jurisdictions don’t require witnesses to legitimize this document, you may consider getting a notary public to sign it. A notary public will ensure all parties sign the document as themselves and without coercion.
If the title company or lender requires notarization, they will arrange for a notary public to be available at the closing.
Loan Agreement Terms and Conditions
A loan contract contains basic details, including the principal amount and interest. Explore some other terms and conditions that you can include within this document:
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Payback Options: This document can outline the desired payback option. For example, a lender may want the borrower to pay:
- On-demand
- In full on a certain date
- In installments of interest only (with the principal due at a later date)
- In installments of the principal and interest
- Assignment: Assignment refers to letting a lender sell their right to collect payments from a borrower. This option may be useful if the lender no longer wants to collect payments from the borrower.
- Guaranty: A guaranty provision states that a cosigner will become responsible for the loan if the original borrower fails to repay the entire amount.
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Acceleration: An acceleration clause explains whether the lender can increase the repayment date or make the borrower repay the loan immediately. Possible triggers for acceleration include:
- The borrower becomes bankrupt.
- The borrower fails to follow the agreed-upon payment schedule.
- The borrower wants to pay off the note early.
- The borrower sells off a significant or material portion of their assets.
- Amendments: An amendments clause can outline how either party can alter the original agreement.
- Collateral: A collateral provision is essential for a secured loan, as it defines what property the lender can keep if the borrower defaults.
- Prepayment: A prepayment clause determines if the borrower can pay off the loan and interest early. If the lender permits, this clause may allow the borrower to receive a discount for early payment.
- Late Charges: A late charges clause states that the borrower is responsible for paying penalty fees if they make late payments.
- Joint and Several Liabilities: Joint and several liabilities state that all borrowers are individually responsible for the total loan amount.
- Maturity Date: The maturity date defines when the borrower should repay the full amount.
How to Write a Loan Agreement
Step 1 – Name the Parties
This agreement should detail the lender’s and borrower’s full legal names.
Step 2 – Write Down the Loan Amount
Provide the amount the borrower will be loaning from the lender. This amount is the principal sum. It doesn’t account for the total amount, including accrued interest.
Step 3 – Specify Repayment Details
This section is where you must provide the details of the borrower’s loan repayment. The options you choose will have to be mutually agreed upon. You can choose whether the borrower will repay the loan in regular payments or at once.
- Regular Payments: The borrower repays the lender in a set number of payments over a specific period.
- Single Payment: The borrower repays the lender all at once by the date specified by the lender OR “on-demand” by the lender. With a “Due on Demand” payment option, the borrower repays the loan upon the lender’s demand.
If you choose regular payments, you must specify the repayment schedule, which can be monthly, quarterly, semi-annual, or annual installments.
Step 4 – Choose How the Loan Will Be Secured (Optional)
If you want the loan secured, you can include the property the borrower has put up for collateral. Make sure to provide as many relevant details as possible. Both parties must mutually agree upon this collateral for it to be legally valid in court.
Step 5 – Provide a Guarantor (Optional)
A cosigner or guarantor is optional and protects the lender if the borrower defaults on the agreement. You may require a cosigner if the borrower is in questionable financial standing. The cosigner is someone who jointly signs the agreement with the borrower.
If the borrower defaults and cannot pay back the amount in full, the cosigner is responsible for paying you back the due amount. The cosigner is usually someone in good financial standing or has excellent credit.
Step 6 – Specify an Interest Rate
You should include the interest rate you will be charging the borrower in a percentage. This interest rate will apply to the principal amount of the loan, and the borrower must agree to this rate.
Step 7 – Include Late Fees (Optional)
As a lender, you can charge late fees if the borrower does not make a payment in time. Including a late fee can motivate the borrower to make payments on the agreed dates.
Step 8 – Determine Options for Prepayment
You can include whether penalties or discounts will apply if the borrower decides to pay the loan amount ahead of schedule. Alternatively, you can explicitly state that the agreement does not allow prepayment of the loan.
A penalty can prevent the borrower from paying the loan early and encourage long-term payments. The loan would then accrue more interest, which can be a favorable arrangement for the lender.
Step 9 – Include Provisions for a Default
When the borrower cannot repay the loan as the loan agreement details, the borrower has entered into default. It would be best to clarify how the borrower will default in the document. An agreement can say missing one payment causes a default, but a lender may choose to be more lenient.
A default can give you the legal right to accelerate payment. In this scenario, you can make the total loan amount due immediately.
Step 10 – Add in Relevant Terms
Further terms make up the remainder of the agreement and serve to protect the rights of both parties, and they include any remaining provisions such as:
- The legal right of the lender to enforce the terms of the agreement
- The costs and expenses associated with taking the case to court
- The transferability of the agreement
- The capability of alterations to part of or the entire agreement
Step 11 – Specify How You Would Like To Communicate
You can establish communication methods so both parties are on the same page. This preparation can prevent either party from claiming they didn’t receive a notice.
Step 12 – Include the Governing Law
Indicate your resident state in the agreement so both parties know which jurisdiction’s laws they must follow.
Step 13 – Determine the Resolution Method for Disputes
Detail the procedure for how both parties can resolve disagreements. Choose from several options, including court litigation, mediation, and arbitration.
Pursuing court litigation will mean the party who lost the case must pay the other party any costs and fees related to the court process.
Step 14 – Include All Relevant Signatures
All involved parties in the agreement, including personal guarantors and cosigners, must sign the document.
Documents Necessary for a Loan-Financed Purchase
Here are the documents you may need for a loan-financed purchase and at what stages you may need them:
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Before the Loan Agreement:
- Loan Application: A prospective borrower submits a loan application to formally request a loan.
- Proof of Income: Proof of income can include tax returns, W-2 forms, pay stubs, and other documents that testify a borrower can repay a loan.
- Purchase Agreement (For Real Estate): This document explains the terms and conditions under which a buyer will buy a property from a seller.
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Along with the Loan Agreement:
- Promissory Note: A promissory note is a simple document that outlines the repayment terms for the loan.
- Mortgage Deed or Deed of Trust: A mortgage deed or a deed of trust secures the loan against the property that the buyer purchases.
- Personal Guarantee: A personal guarantee is a promise a person makes to repay the loan if the borrower can no longer repay it.
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After the Loan Agreement:
- Closing Disclosure (For Real Estate): The closing disclosure offers a summary of the loan terms, including the interest rate, monthly payments, and closing costs.
- Security Interest (For Secured Loans): The security interest explains the lender’s security interest in collateral, such as a vehicle or piece of property, to ensure repayment of the borrowed sum.
- Bill of Sale (For Secured Loans): A bill of sale facilitates the transfer of property ownership from the seller to the buyer.
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Additional Documents (Depending on Loan Type):
- Appraisal Report (For Real Estate): An appraisal report offers an impartial opinion of a property’s value, as it considers the property’s condition, market trends in the area, and comparable sales.
- Title Report (For Real Estate): A title report reveals the legal ownership of the property and notes any existing encumbrances or liens.
- Homeowner’s Insurance Policy (For Real Estate): A homeowner’s insurance policy protects the property against liability, loss, and damage.
Loan Agreement Sample
Download a free loan agreement template as a PDF or Word file below.
Frequently Asked Questions
What’s the difference between a loan agreement and a promissory note?
A loan agreement and a promissory note are legal documents individuals use when borrowing money from another party. However, promissory notes tend to be shorter and more straightforward. They focus on the borrower’s pledge to repay and contain basic elements like the parties’ names, the loan amount, and the terms.
Loa agreements are more comprehensive since they outline the loan’s terms and conditions in greater detail. They often give both parties more protections, including borrower representations, warranties, and covenants. For more detailed information, you can explore the differences between a loan agreement and a promissory note.
Can you cancel a loan agreement?
You can cancel this agreement in certain instances. Refer to the original document for termination conditions. You may also be able to cancel the loan if both parties agree to it or if you’re within your jurisdiction’s cancellation period for your specific loan type.
Can I write a loan agreement with a family member?
Yes. Consider writing this agreement when borrowing money from or lending to a family member. This agreement can help keep matters objective if you disagree about the loan’s terms later.
What does it mean to consolidate your loans?
Consolidating your loans involves obtaining one sizable loan to pay off all your loans. This way, you only have to make one payment each month. Consolidation may be a reasonable option if you can secure a loan with a low interest rate.
