A loan agreement is a contract between the borrower and the lender stipulating the terms and conditions for the grant of loan to the borrower. A loan can be taken from a lending institution, friends, family member etc.
A loan agreement is essential irrespective of the fact to whom it is given. Even if the loan is given to a friend or a family member, it’s always better to have a loan agreement. It serves as a legal document for settling disputes that may arise between the borrower and the lender later.
Download ‘Loan Agreement’ Sample Format
Requirement of a Loan Agreement
The loan agreement provides details of how much loan is lent to the borrower and when the borrower needs to pay it back. The execution of the loan agreement acts as a promise to pay the loan amount from the lender to the borrower. Borrowing or lending money is a big commitment, thus it is important to protect both parties by executing a loan agreement.
A loan agreement serves as proof that the money was given as a loan and not as a gift to the borrower. It prevents the borrower from trying to get out of repayment of the loan amount. It is necessary to execute a loan agreement even if the money is borrowed from a friend or family member. It is better to have a loan agreement to make sure that there are no disagreements or issues over the terms later on which could even ruin a relationship.
Contents of a Loan Agreement
A loan agreement contains the following information:
- Loan Amount and Duration: A loan agreement clearly specifies the amount of loan (also called Principal Amount) given to the borrower. The document also defines the time period for which the loan is granted.
- Interest Clause: It states the rate of interest to be paid along with the principal by the borrower. Also, it specifies the penal interest or additional charges required to be paid in the event of default in the payment of interest and principal.
- Repayment Clause: It is the major element in the loan agreement. This clause specifies how and when the loan is to be repaid by the borrower to the lender. The repayment can be a lump sum or on a periodical basis. In case of periodical payments, it should specify the number of installments due and the date when the installment becomes due.
- Prepayment Clause: Prepayment means early payment of loan i.e. payment before the due date. Prepayment of loan is generally allowed on the payment of penalty charges. The penalty is levied to protect the lender against the loss of interest payments.
- Loan security: A loan can be secured or unsecured. In case of a secured loan, generally, some asset, say house or vehicle is pledged as collateral for the loan. In the event of default, the security pledged can be used to recover the loan amount.
A loan agreement must be signed by both the parties (borrower and lender) in order to avoid any dispute that may occur later.