How to draft a loan agreement
Drafting a loan agreement is a simple process; however, it must be done carefully to ensure the lender and borrower are properly accounted for. A loan agreement can be as simple as a single sentence or as complicated as a document containing multiple clauses and sections. Regardless of how detailed a loan agreement is, it must contain vital information for it to be valid.
Decide on terms of the loan. Decide on a principal loan amount and how the loan will be repaid. For larger loans, monthly payments are common. For shorter loans, there may be only one or two instalments required to satisfy the contract. If repayment will include interest, make a note of the rate you will charge the borrower.
Calculate payments based on the agreement's rate of interest. If you are charging interest, each payment must include principal and interest. The formula for calculating principal and interest payments looks like this: P= principal (loan amount), R= rate of interest, N= number of payments in months.
P ( r / 12 ) ------------------------- -n (1 - ( 1 + r / 12 ) )
Using actual numbers, a thee-year (36 month) loan of £9,750 with a rate of 7 per cent, the formula would be calculated as illustrated below.
15000 ( 0.07/ 12 )
-36 (1 - ( 1 + 0.07 / 12 ) )
The monthly payment on this loan will be £301.0.
Draw-up an agreement. There are several ways you can draft a loan agreement. Regardless of how you do it, you must include the date on which the agreement will begin,names of both parties, loan amount, and the monthly payments and their due dates. It is also wise to include a clause that states what will occur in the event the borrower defaults. A sample loan agreement looks like this:
I_ (borrower name) or we****_, promise to pay (lender name)**** the principal amount of_ ****____.
We agree that the above loan amount will be repaid with the interest rate of _%.
The note shall be paid in _(number) of instalments of $**** (monthly payment in dollars) beginning on **** (date of first payment) and on the _ day of the each month thereafter until the principal interest are paid in full.
The borrower agrees under this agreement that if payments are not received within _____ days of their due date, the lender reserves the right to accelerate this agreement and demand the entire principal and interest amount be due in full and to collect these amounts through legal action and/or the assistance of a third-party collection agency. The lender also reserves the right to collect from the borrower any attorney's fees and other collection costs.
The borrower reserves the right to pay this loan in full before the due date of the final payment with no penalty.
Include loan security if applicable. If the loan is attached to a security, such as a car, include a clause which indicates borrower and lender right pertaining to the security. A sample clause looks like this:
"I (borrower) agree that the above loan is secured by a 2004 Ford Focus automobile, VIN Number:____. The borrower agrees to surrender the title to this automobile to the lender until the loan is paid in full. In the event of loan default, the lender reserves the right to gain possession of the vehicle. Lender may sell the vehicle and use funds to satisfy the terms of this agreement of the borrower defaults. Lender may also collect any unpaid funds not covered by the sale of the automobile and collect any fees associated with vehicle storage, legal action and repairs to the vehicle."
Never sign a loan agreement if you do not fully understand its terms. Consult with an attorney if you need help.
- Terms of the loan
- Signatures of borrower and lender