If you’re eager to sign for a loan to get the money you need, hit the breaks and read everything involved with the loan first. Loan agreements are binding contracts, so you will want to be absolutely sure you know what you are getting into and that you approve of all the terms set forth by the lender.
The structure of the loan agreement will vary by lender and loan type, but the agreement will include many of the following details. Some terms are clearly stated and easy to understand, while other particulars will be found in the fine print and can be a little puzzling.
Loan Terms and What They Mean
Your signature indicates that you’ve read, understood, and consented to the contract. It will be very hard to get out of the deal once you sign, so approach this process seriously. This is your opportunity to approve or deny the loan.
You will see the sum of money you are borrowing written on the agreement. This amount should be neither more nor less than what you discussed or was presented to you online.
Check the date the lender will release the money to you. If you were expecting the funds sooner, make a note of it.
You will see the name and address of the lender as well as your name, Social Security number, and contact information. If there are any cosigners, their information will also appear.
Make sure spelling, Social Security numbers, addresses, emails, and phone numbers are correct. If something is not correct, your statements may not arrive as they should. There will also be a place for all parties involved and possibly a witness to sign.
Your loan agreement may include a guarantor who has agreed to pay your debt if you default on the loan. This is a person you’ve chosen and the lender has approved, likely through a credit check. The contract will include that person’s name and contact information.
If you borrow money to purchase a home, vehicle, or other property, the lender may want a down payment and you will finance the rest. Or you may elect to make a down payment so you don’t have to take out such a large loan.
Whatever the case, the contract will list the amount you have already paid the lender or that you are expected to pay as a down payment.
This will specify how the lender expects the loan to be repaid. For example, it could be on demand, which is an acceleration clause that allows the lender to demand you pay the entire amount in full at any time.
If that makes you uncomfortable — and it should — this would be a good reason to back away. The most common repayment arrangement will be for you to pay in regular, fixed installments.
The repayment term will be expressed in the number of months rather than years. So if you take out a loan with a three-year term, it will show that you have 36 months to pay.
Most lenders give you a fixed number of days to make a payment after the due date has passed without imposing a late fee or considering the account in default. This grace period gives you some wiggle room when you can’t get the entire payment in on time. For example, if your payment is due on the 1st, the lender may give you until the 10th to get it in.
The agreement will specify the annual percentage rate (APR) attached to the loan. It will also state whether that rate is fixed or variable.
A variable rate typically begins low and may increase in the future. When it does, you may find the payment too large to handle, and the loan will be more expensive than you initially thought.
If the rate is fixed, your payment will remain constant for the entire term. You can accurately plan for payment and the amount of added interest.
Loans may be unsecured, which is the case when the lender issues a loan based only on your income, debt, expenses, and credit rating. If it’s secured, the lender looks at those factors but also considers the collateral the borrower provides, which minimizes lending risk.
The loan is collateralized by property or monetary assets, and the lender can take possession of the collateral in case the loan goes into default. The agreement will specify what the collateral is and at what point the lender can take it.
Depending on the loan, the lender may tack on a host of fees. The complete list will be on the agreement. There may be an application fee to process the loan for a home or car loan.
Mortgages often come with fees for costs associated with closing, pulling credit reports, recording, document preparation, and home inspection. Many types of loans charge origination fees, which is an upfront cost to cover processing.
As a borrower, you are expected to make your payment on a specific date or within the grace period. The loan agreement will specify how much the lender can charge as a late fee if you do not pay by that date.
You may want to have the option to pay the loan off early without any financial repercussions. Check to see if the lender will charge you a penalty if you satisfy the loan before the term ends. While you have a right to pay the loan off at any time, the prepayment penalty ensures that the lender doesn’t lose too much money if you do.
Some loans, especially mortgages and vehicle loans, are structured in such a way that you make small payments for much of the life of the loan and then have to make a large payment at the end. You will see what that balloon payment will be on the loan agreement so you are not surprised when the lender expects the money.
If you don’t make your payments by the due date or within a grace period, your loan may go into default. The loan agreement will clarify what constitutes a default and how you get out of it. It will also state the remedies it can take if you go into default, such as demanding all future installment payments plus interest to be paid immediately or how it may instigate legal action.
Business loans can have extra clauses you should check, including the cross-default provision. If you see this, know that if you default on one loan and have other loans with that same lender, it can trigger a default on all of them.
A few installment loans, such as loans for furniture or appliances, come with deferred interest arrangements. You won’t be charged interest as long as you pay the entire balance in full by the specified date. But the lender will be keeping track of the fees you would be charged, and if you fail to pay the entire amount by the end of the term, the lender will add all that accumulated interest onto the bill.
Choice of Law
The way loan agreements are interpreted and enforced depends on state law, so your agreement will indicate which state laws will be applied if problems arise. Don’t assume it’s the same state you live in or where you sign the contract. It could be the jurisdiction in which the lender operates.
What to Do When the Loan Agreement Isn’t Acceptable
After you have finished reading the loan agreement, you may find certain details unacceptable or confusing. If so, do not sign.
Contact the lender, ask for clarification, and make changes when necessary so you are satisfied with the agreement.
If you are still unclear or the lender is unmoving, consider this a sign to take your business elsewhere. At that stage, you can start to look for a new lender that will be more amenable.
Be aware that the higher your credit score, the better the loan terms are likely to be. This could be a sign for you to wait and bring your credit scores up before applying again.
Why Loan Agreements Are Good For Lender and Borrower Alike
In the end, a loan agreement protects both you the borrower and the financial institution lending the money. The lender does not have the right to change any of the terms unless the agreement outlines that ability.
If you don’t follow through on your end of the bargain, there may be some negative consequences. But when everybody follows the rules, all will be well.
Even though there is a lot to read and understand, a contract is designed to put all parties on the same page. Each of you will have written and signed proof that you were aware of everything involved in the loan from start to finish.