Reviewing a Loan Agreement
Before providing a loan, or taking one out, you must understand what to consider in your loan agreement so that you're not signing up to the unknown. Providing loans might be an investment worth considering for yourself or your company which favours both the borrower and you. By the same token, borrowing money can be an integral step to your financial success. So it's only right to brush up on the key terms you should be reviewing to make sure that your loan agreement protects all parties involved.
Keep reading to make sure that you're up to speed with the top things to consider for reviewing a loan agreement.
What are the key terms of loan agreements?
If you're looking into lending or borrowing funds, and want to firm up a written agreement, then thinking about the terms of the loan should be your very first step. There is more than just the loan amount and interest rates to consider when one party is lending funds to another. Given that a loan agreement or loan contract is a legally binding document, care must be taken to make sure that you've covered all bases.
Below, we cover the key terms you should seriously revise for your loan agreement.
1 . Is the loan a secured loan or unsecured loan?
Deciding on whether to require collateral from the borrower to secure the loan is an important consideration in a loan agreement as it can affect other terms of the loan (such as the interest rate).
Unsecured loans create slightly higher risk for lenders, as they don't have the borrower's property to fall back on if the borrower defaults on the loan, which tends to attract higher interest rates for that reason.
2 . Are the repayments to be over a Fixed Term or On-Demand
Typically, most loans out there are to be repaid over a fixed term schedule, where the borrower repays the principal and interest via monthly payments (or another agreed-upon payment frequency) until the loan end date or maturity date.
There is, however, the option to set a provision in your agreement where the loan is to be repaid on demand. With on-demand loans, the borrower is to repay the full amount of the outstanding balance to the lender immediately on request; these loans are usually put in place if the borrower has bad credit.
3 . Deciding if a Prepayment option applies
Being able to 'pay off' a loan early can be either advantageous or detrimental, regardless of whether you're the borrower or the lender. The amortization table that is drawn up by the lender, will lay out the repayment schedule made up by periodic loan repayments. The schedule will illustrate the principal and interest payable with each monthly payment the borrower makes. Due to this, you may wish to set a term that only permits prepayments at the end of an interest period.
Certain loans may also stipulate mandatory prepayments, for example, when the borrower sells a business or company.
4 . Setting the interest payments
You're probably very familiar with the concept of paying interest on a loan, however, deciding on the type of interest rate applicable to your loan agreement can be a little more involved.
Generally, with an interest clause of an agreement, there are two primary interest rate types:
Fixed fee rates
Floating fee rates
Most loans typically use a fixed rate fee; however, you may look to set a floating rate, which is based on adding a margin to a benchmark interest rate. Usually, only the more complex or complicated loans in Australia use this fee rate. Using the floating fee rate, you may stipulate that the floating rate is 2.5%pa over a set benchmark, for example.
To access more information about setting a benchmark rate, you may like to consider the Bank Bill Swap Rate (BBSW) or the cash rate target set by the Reserve Bank of Australia (RBA).
5 . Agreeing on the 'Events of Default' for if the borrower defaults
Considering the events of default is often considered one of the most important elements in a loan agreement. Depending on the type of loan in place, the definition of a default will differ slightly.
Some of the major default events to be concerned with are:
Non-payment of the loan automatically triggering a default.
Breaching the loan agreement. Where any breach of the terms in your agreement automatically causes a default.
Cross defaults. If any other facilities are provided by the lender and are on-demand and suffer a default, it could automatically cause this loan to default too.
6 . Choosing a Default Interest Rate
It's prudent to consider including a default interest clause, which will set out the interest charged on any overdue amounts that aren't paid when they're supposed to be. If the rate is too excessive, it could be deemed to be a 'penalty' rate and won't be able to be enforced if a dispute occurs.
7 . Check if the loan is bilateral or syndicated
When one party decides to lend money to another, the loan is considered to be bilateral. In the case where two or more parties act as the lender and jointly provide funds to a borrower, the loan agreement is syndicated.
Syndicated loan agreements are usually only when the loan amount is very high, and the lenders are an investment or corporate banks.
8 . Is the Loan agreement to be committed or uncommitted?
You may not have realized that your loan agreement can be either committed or uncommitted. Committed loans mean that the lender is contractually obliged to loan the borrower the money as soon as they satisfy conditions precedents (CPs).
Should I use a promissory note or a Loan contract?
When you are looking at drafting a loan agreement, if it's a small loan, particularly between you and a family member, you may look to use a promissory note instead of a written loan agreement. Essentially, a promissory note is a record of one person lending money to another, which outlines the amount owed; you might consider these to be a formal type of IOU.
While these note types are great for lending money between friends or family members, you must exercise caution as they can quickly become a complex financial instrument that's subject to the governing law within the Corporations Act (2001).
Regardless of whether you choose to go with a loan agreement or a promissory note, drafting any legal documents should be done with the assistance of a law firm such as Bradley & Bray.
When does the National Credit Code apply?
The National Credit Code (NCC) may apply to your loan, depending on the type of loan it is. Generally, the National Credit Code applies to loans that aren't for business purposes, such as personal loans for cars or household purposes.
It's important to note that the NCC doesn't apply to a short term loan and is only for when you borrow money from an institutional lender.
Going into debt or borrowing money should never be taken lightly. Before you put a legally binding contract in place for a personal loan or business loan, make sure to get in touch with us at Bradley & Bray. We provide a wide range of personalized legal services and can provide legal advice around the entire agreement process so you can draft your loan agreement with confidence.
This article is general in nature and does not constitute legal advice. If you require legal advice in relation to your personal circumstances, you must formally engage our firm, or another firm to provide legal advice in relation to your matter. Bradley & Bray lawyers takes no responsibility for any use of the information provided in this article.
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