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Business loan agreements govern the relationship between borrowers and lenders by detailing key information such as repayment terms and collateral. The loan agreement protects all parties to the contract by ensuring that everyone understands their rights and responsibilities. For this reason, it is important to understand the most common sections and terms of a loan agreement.
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What is a professional loan contract?
A commercial loan agreement is a legally binding document that describes the details of a loan between a lender and a borrower. Loan agreements typically include information such as loan amount, repayment term and due dates, interest rates, and other costs.
Not only do the best small business loans offer competitive rates and terms, but they also come with transparent loan agreements that business owners can understand.
How a business loan agreement works
Business loan agreements are usually provided by the lender, especially when working with banks, credit unions and other financial institutions. However, business owners who take out a private loan from an individual may need to provide their own agreement. If so, there are a number of agreement forms and templates available online.
Keep in mind, however, that it’s best to consult a business lawyer when drafting a loan agreement. Likewise, it’s important to understand the most common sections of a loan agreement before it’s time to get a business loan.
Sections of a Commercial Loan Agreement
Most business loan agreements include the same general sections. The majority of variation occurs in these sections, where lenders can set their own terms and establish loan details as well as repayment, default and default mechanisms. Here are some of the most common parts of a commercial loan agreement:
The effective date of a commercial loan agreement is the date it becomes binding on all parties. With a loan agreement, this is usually the day the loan funds are disbursed.
Parties, relationship and loan amount
Every loan agreement should include the names of the lender and borrowers at the beginning of the document, including each party’s address or other identifying information, and the relationship between the parties.
If there is a co-signer on the loan, also include identifying information and describe their relationship under the contract. Finally, indicate the amount of the loan in this first part of the contract.
Promissory note or mortgage
A promissory note is a part of a loan agreement stating that the borrower agrees to repay a fixed loan amount at a fixed interest rate. As the name suggests, a promissory note is simply a promise to pay.
For a secured loan, the loan agreement should include a section describing the collateral, usually referred to as a collateral agreement. In the case of a mortgage, the underlying security is the land and/or building purchased. However, collateral can also be the financed vehicles or equipment, or other company assets.
Terms and conditions
This section of a business loan agreement typically includes the details of an installment loan, including the installment agreement, as well as basic information such as the loan amount, term, and interest rate. This section may also indicate whether prepayment is permitted under the terms of the agreement.
Penalties for non-payment
The non-payment section of a loan agreement describes what happens if the borrower misses a payment. Typically, this section indicates if there is a grace period during which the borrower can make a late payment without being penalized.
Default and Acceleration Clause
This section describes what happens if the borrower defaults on the loan, including fines and other penalties. Similarly, the contract may include an acceleration clause which states that the entire balance of the loan becomes due immediately if the borrower fails to meet all of the requirements set out in the agreement.
Jurisdiction and applicable law
Since the law varies from state to state, every commercial loan agreement must include a section that specifies the controlling state law. This is particularly important in the case of a contract dispute, but it also dictates how the overall contract is drafted. For this reason, it is best to hire a local attorney who can ensure that the loan agreement complies with applicable state law.
Representations of the Borrower
As part of a loan contract, the borrower is expected to make a number of representations. This may include asserting that the borrower can legally do business in the state, that all financial statements made are true and correct, and that the business is in compliance with tax laws.
A covenant is a promise made between parties to a loan agreement. Typically, the lender agrees to disburse funds of a certain amount and at a specified interest rate, while the borrower promises to repay the loan according to the terms of the agreement. However, there are several more specific commitments found in business loan agreements, including a promise to:
- Provide proof of insurance for pledged collateral
- Take out key person insurance on the life of the entrepreneur
- Show proof of payment of taxes and fees, including property taxes and vehicle licenses
- Pay the lender’s fees in the event of default
- Periodically produce financial statements during the term of the loan
- Refrain from incurring additional commercial debt during the term of the loan
Terms of commercial loan agreement
With all the legal jargon present in business loan agreements, it can feel like the documents are written in another language. However, understanding a few common terms can make it easier to interpret these contracts. Familiarize yourself with these terms before signing a loan agreement:
- Amortization. Loan amortization refers to how a fixed rate loan is spread in equal installments over the repayment term. Typically, each payment includes interest and a payment on the principal of the loan.
- Annual Percentage Rate (APR). The APR on a loan represents the annualized cost of borrowing, including the interest rate and additional fees and commissions.
- Automated Clearing House (ACH). In the context of business loans, automated clearinghouse payments are a type of loan payment that is made by automatic withdrawals from the borrower’s bank account.
- Balloon payment. Typically, term loan repayments include a portion of accrued interest and a portion of the loan principal. In this case, the principal is fully repaid over the life of the loan. However, some loans are structured so that some or all of the loan principal remains at the end of the term and must be repaid in one lump sum payment.
- General privilege. A general lien covers all of a company’s assets, not just a specific collateral item. In the event of borrower default, this type of lien allows the lender to attach itself to one of the borrower’s assets to collect the outstanding loan balance.
- Co-signer. A co-signer is someone who can improve a potential borrower’s chances of getting approved for a loan by agreeing to repay the loan if the primary borrower defaults. If applicable, the co-signer for a commercial loan is identified in the loan agreement along with their responsibilities under the agreement.
- Reduction. Reduction refers to when a borrower pays more on their loan than is currently due in a month, or more than the monthly payment set out in the loan agreement. A partial reduction occurs when the borrower makes an additional payment but does not repay the entire loan; a complete reduction implies full repayment of the loan.
- Fault. Default on a business loan occurs when the borrower fails to make payments in accordance with the loan agreement. If a borrower defaults, the lender can take legal action to recover the loan balance from the borrower or co-signer.
- deferred repayment loan. With a deferred payment loan, the lender and borrower agree that payments will begin on a specified future date, not immediately, as is the case with traditional term loans.
- Factor rate. Some types of business financing, such as invoice factoring and merchant cash advances, have a factor rate instead of a traditional interest rate. Unlike traditional interest rates, factor rates are expressed as a decimal number that represents the factor of the total loan amount that will be repaid in total. For example, if the factor rate on a $10,000 loan is 1.2, the borrower will repay a total of $12,000.
- Interest only payment loan. An interest-only payment on a loan covers only a predetermined portion of the interest accrued on the loan, not the principal of the loan itself. When the term of the loan expires, the principal of the loan is repaid in full or refinanced.
- Loan-to-value ratio (LTV). The corporate finance loan-to-value ratio represents the portion of an asset’s value that is covered by a loan. This is particularly relevant for companies wishing to finance the purchase of equipment or real estate.
- Loan subscription. Underwriting is the process a financial institution uses to assess the risk a borrower poses to the lender.
- Prepayment Penalty. Some lenders charge borrowers a prepayment penalty for repaying a loan before the end of the full loan term. Since lenders expect interest to accrue for the life of the loan, paying off a loan early can result in a loss of those funds. Prepayment penalties are intended to compensate for this loss.
- Major. Loan principal is the amount a business borrows – the loan amount – excluding accrued interest. Part of each loan payment covers interest, with the rest covering part of the principal.
- Refinancing. The process of refinancing involves taking out a loan to pay off the balance of another loan. Refinancing is often used to access lower interest rates or to reduce the monthly payment on an existing loan.
- Maintenance. Loan servicing is a general term that refers to the management of a loan, including how loan funds are disbursed, how payments are collected, and what happens if the loan defaults. borrower.
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