How to Understand a Business Loan Agreement

If you are a new business owner considering applying for a business loan, you need to make sure that you have carefully reviewed your business loan agreement. This document outlines the terms, conditions and other logistical details of the loan, which you must record for legal and repayment purposes. Whether you are borrowing money from a traditional bank or a third-party lender, the loan agreement will play a key role in helping you determine whether the loan and repayment procedures meet your current financial needs.

Ideally, it’s best to bring in a lawyer to look at the problematic clause, but this isn’t always possible, especially for sole proprietors and new small business launches. However, you can still describe the business loan agreement yourself by paying attention to the following components, terms, and items.

Key Takeaways

  • A business loan agreement documents the terms and conditions of the loan and also includes important information such as the loan amount, payment details, APR, and fees.
  • When reviewing business loan agreements, pay attention to clauses about prepayment fees and penalties, and personal guarantees.
  • Consult a lawyer if you cannot clearly understand any part of the document.

What is a Business Loan Agreement?

A business loan agreement is a document that outlines the current and future logistical terms and conditions (payback) of the loan. It is a legally binding agreement signed by both parties to establish clear responsibilities and help borrowers and lenders feel secure in the arrangement.

A business loan agreement is usually required when you take out a loan to start a new business, purchase an existing business, upgrade machinery, hire new staff, or fund other operations that will help keep your business running.

Components of a Business Loan Agreement

Business loan agreements may come in various formats with different sections, however, most of them have some common features that are legally required. Here are the most important components that are usually included in a business loan agreement.

Business Loan Amount

The first component of a business loan agreement is the amount of money borrowed, also known as a promissory note. This will usually be expressed in words and in numeric format. For example, a business loan agreement could say something like “The Borrower has requested that the Lender provide a loan to the Borrower in the amount of Fifty Thousand No/100 Dollars ($50,000).”

Payment Information

Loans will need to be repaid at some point in the future, so this section highlights the exact process and timing for repayment. This will include details about your payment schedule, grace period, and late payment fees and accepted payment methods (credit cards, electronic transfers, bank deposits, etc.), the amount to be paid monthly or quarterly, and so on.

April

When you borrow money, you are not only paying back the amount borrowed. You are usually charged an interest rate. This annual percentage rate, or APR, tells you how much you will pay in interest each year when you repay the loan along with whether the interest rate is fixed or variable (and when/if it will change).

Penalty Fee

What happens if you fail to return the money due on time? You are usually charged a late fee or a higher interest rate, depending on the terms of your agreement. Also called a penalty fee, this can be imposed if you violate any of the payment terms outlined in your agreement.

Items to Watch Out for

Along with the traditional components of a business loan agreement, you also need to pay attention to certain parts of the document that may be problematic.

Upfront Cost

While some lenders will charge an upfront fee to cover your loan processing administrative costs, you usually don’t have to pay exorbitant fees up front to receive a business loan.

Personal Guarantee

If you don’t have enough business assets to use as collateral for a loan, some lenders may ask you to use your personal assets (house, car, etc.) as collateral. This gives the lender the right to foreclose on your personal property if you are unable to repay the loan on time.

Prepayment Penalty

While it’s ideal to pay off your loan early, some lenders may fine you for doing so. If you pay before the due date, the lender earns less interest on the loan amount and therefore they may insist that payments are made only according to the scheduled time schedule. Be sure to review the fine print to see if this will affect you, especially if you think you might want to repay your loan early if you have an inflow of cash.

When applying for a business loan, it’s also important to understand your lender’s definition of a loan default, sometimes referred to in loan agreements as an “Occurrence of Default.” Some lenders will offer a grace period for one or two payments, while others will pursue collection and/or legal action after one missed payment or if there is a misrepresentation in the financial statements, statements, or certificates provided to them.

Important Terms to Know

Here are some important terms to know when reading a business loan agreement.

Amortization: This outlines how your loan payments are arranged. Amortized loans mean that you will repay your loan in equal, scheduled payments usually every month.

Balloon payments: Some loans require hefty lump-sum payments at the end of your loan term. This usually happens if you have made interest-only payments; This balloon payment amount is intended to pay off the principal debt.

Blanket lien: This gives the lender the right to your business assets and property if you default on your loan.

Co-signer: A co-signer signs a business loan agreement with you and is responsible for repaying the loan if you fail to do so.

Default: Default occurs when you fail to fulfill your contractual obligations (for example, fail to make payments on time or violate one of the lender’s “Default Events”). Defaults can result in lenders seizing your assets or imposing penalties.

Proof of insurance: This documentation shows the lender that you will maintain and apply insurance to cover you against liability from industry-specific issues, fire, property damage, workers’ compensation, etc.

Indemnity: It is designed to protect the lender against any and all claims, liabilities, losses, damages and expenses.

Before You Sign Your Loan Agreement

Before signing a business loan agreement, be sure to read the fine print to make sure there are no problematic causes that will get you in trouble in the future. It is important that you understand exactly what each term means and how it will affect your payout.

In addition, consider the trust of the lender. Avoid lenders with high rates, suspicious policies, and fraudulent practices. You can usually inquire about business loans at your local bank. Finally, consult a lawyer if you are unable to understand what the clause means and how it affects your business.

Frequently Asked Questions (FAQ)

What is not covered by a business loan agreement?

While most loan agreements can be very comprehensive, not all documents include every section detailing all the processes. For example, some agreements may not include information about the repayment method and focus only on the timing and amount of the payment.

Why are loan agreements important?

Loan agreements are important to ensure the borrowing and payment processes are recorded for legal reference. Having the document signed also helps to ensure both parties are on the same page regarding loan and repayment expectations to avoid future problems. A loan agreement can serve as a useful reference for tracking repayment times, interest rates, and penalties for default.

How to write a legally binding loan agreement?

It is best to consult a lawyer or relevant expert to write a legally binding loan agreement. If that’s not accessible for your business, make sure your documents include all major components and fair clauses to ensure you don’t overturn any legal policies.

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