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What is a Loan Agreement?

Wednesday 22nd Feb, 2023

When borrowing money, whether it’s from a business, family member or friend, it is very important that the transaction is backed up by a properly drawn up Loan Agreement.

A Loan Agreement is a legally binding document between a lender and a borrower that sets out the terms on which the lender is prepared to loan the money, and the mutual obligations of both parties.

The lender is the person or organisation (for example your credit union) that gives you a loan in return for your promise to pay it back, usually with interest, over an agreed period.

The borrower is the person or organisation that receives the loan and pays it back.

Before borrowing money, for your own protection, always insist on seeing a Loan Agreement and read it thoroughly to make sure that you fully understand the terms of the loan and the repayments that you are expected to make.  If you are at all unsure about anything it contains, you should ask the lender to explain, and/or if necessary, seek legal advice before you sign the agreement.

A well-drafted Loan Agreement should include at least the following information:

• The name and address of the lender and the borrower;
• The amount of money being loaned (or the credit limit);
• Any amounts outstanding on a previous loan that is included;
• The repayment plan: how much and how often/when repayments are to be made;
• The interest charges (if any) (%APR) to be paid and how calculated;
• What will happen if payments are made late or missed altogether;
• What happens if you wish to repay your loan early;
• Whether the loan is made with any security to protect the lender.

Where a loan is made by a business, the lender must be authorised for lending by the Financial Conduct Authority.  You can check to see if your lender is legal by searching the Financial Conduct Authority’s register of all legal money lenders in the UK.

Alternatively you can call the Stop Loan Sharks Team on 0300 555 2222 in complete confidence and they’ll be able to tell you if your lender is legal or illegal.  

A reputable lender will not mind you taking the time to make these enquiries, and satisfying yourself that all is well, before you sign their agreement.

Most loans made in the course of business fall within the provisions of the Consumer Credit Act, which requires the lender to provide you with certain notices and information as well as quoting the APR (Annual Percentage Rate of interest) that applies to your loan.  

There are several repayment plan options, and your agreement should say which one applies:

• Specific amounts – the borrower makes specific repayments at regular intervals such as weekly, fortnightly, 4-weekly or monthly; the amount is calculated so that the borrower pays back the original loan (known as the principal sum), along with any interest, by the end of the term;
• Lump sum at end of the term – the borrower pays the entire amount back (with interest) in one lump sum on a specified date or upon demand;
• Interest only – Regular repayments are made but only towards the interest; the principal sum is paid off in a lump sum at the end.

Interest is usually expressed as a percentage of the principal amount (say x% per calendar month).  While interest free (0%) loans are quite legal, a lender usually charges interest to recoup the cost of administering the loan and cover the risk of lending money.

Sometimes a loan may be granted with security (or collateral).  This may take the form of an asset (such as a vehicle or property) with an equivalent value to the loan.  If the borrower defaults on their loan repayments, the lender may go to court to gain the collateral to make good their loss.   With some credit union loans, the member agrees to pledge (keep) a savings balance as part- or full-security for a loan.  Because the risk is reduced with this type of loan, the member may enjoy a lower interest rate than otherwise.   The loan agreement should make clear when any security is attached to the loan.

Remember, you should only sign a loan agreement once you have read and understood its terms and conditions and are content to honour them.  

We hope this explanation of Loan Agreements is helpful but don’t hesitate to get in touch if you have any queries.

This article is for general information only and does not constitute financial, legal, or any other form of advice.

 

JES

Last updated 12.2.23.

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