The history of money lending traces back to about 3000 BC in ancient Mesopotamia. Borrowing is a part and parcel of life. During ancient times, oral agreements between the borrower and lender were enough to enter a lending deal. Though today, with so much development around us, it is necessary to govern these agreements to protect the interests of all parties involved in a loan. A loan agreement is a formal document defining the terms between a creditor and a debtor. These days contract drafting services online are available easily. The purpose of executing a loan agreement is to protect the interests of a lender in case the borrower doesn’t repay. Through this article, we explain what a loan agreement is, its importance, and the basics of a loan agreement form.
What is a loan agreement?
The legal document that governs the terms of credit is a loan agreement. A credit is created when one party, i.e., the borrower lends money from a lender to the other party. A written loan agreement helps the lender ensure that the loaned amount will be repaid on the terms that are mutually accepted by the parties. Loans can be of many different types. As a result, the format of a loan agreement can vary from a one-page letter to an entire legal document. The loan agreement form depends on the requirements of both parties.
Who can be a party to a loan contract?
The creditor and debtor are two parties to a loan agreement. Let’s see who is eligible to enter into a loan contract below:
- Family members;
- Other legal entities;
- Banks; and
- Non-Banking Financing Institutes.
Why is a loan agreement important?
When the parties enter into a loan transaction, there is a lot of faith involved. A loan contract is a legally enforceable contract that will protect the interest of the parties in case of any event of default. It will be easier to understand the importance of an agreement from an example:
Rahul needs money for some personal reason. He approached his friend Anamika and she decided to lend him the required amount as a whole. However, since they are friends Anamika decides that she doesn’t need any legalities and skips executing a loan agreement. Now, as per their verbal agreement, Anamika lent Rahul the amount which Rahul had promised to pay within six months. After six months, when Anamika asks Rahul for the same, he denies the fact that it was a loan. Instead, he claims that Anamika had given the money to him as a gift. Here, Anamika will have no legal recourse as she has no proof of giving the money to Rahul as a loan.
In this scenario, if Anamika had executed a written loan contract instead of just a verbal agreement, she would have had the following recourse:
- Legal proof of her loan;
- A way to get the loaned amount back by way of filing a suit for specific relief; and
- A way to protect herself from the loss of valuable resources.
Hence, be it a personal loan from friends, family or be it a commercial loan for business. Having a well-drafted loan agreement is the most secure way of lending money.
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Key elements of loan agreement
Just like all legal contracts, there are standard drafts of loan contract forms available everywhere. However, it is a very important contract, especially because the majority of the time personal relations are involved in loan agreements. As a result, it is important to have a comprehensive loan agreement that helps in mitigating all future risks. Let’s dive into the elements you need to consider before you enter a loan contract:
By Now, we have already cleared that the parties to a loan contract are the creditor and the debtor. The agreement must have a clause defining the parties with their basic details such as the name, age, occupation, and residential/registered address of the parties.
One of the most important elements of the loan contract are details of the loan. Details include the amount of loan, moratorium period if any), maturity date, a penalty in case of delay, interest rate; conditions precedent to disbursement of the loan amount (if any); etc.
Most types of loans happen after collateral or security is given by the borrower. This ensures the lender’s money is secure. In case the borrower fails to repay the amount for any reason, the lender can take ownership of the collateral/security.
Here, the borrower usually represents and warrants the following kind of information:
- That their financial situation is exactly similar to what they portray to lenders;
- the loan amount is used for lawful purposes;
- They are competent to enter into the agreement; and
- That there are no ongoing legal proceedings against the borrower.
A reporting clause is an important aspect of commercial loan agreements. Here, the term of the loan is usually longer than most personal loan contracts. To help govern proper usage of the loaned funds, the reporting clause makes it the duty of the borrower to report regularly, for all the terms of the loan contract.
Covenants or conditions
When the payment or repayment of a loan is based on certain conditions or covenants, all such conditions should be a part of the loan agreement that governs its terms.
Terms of repayment and consequences of default
If the repayment of the loan amount is to be done in installments, the details of each installment, the date, amount to be paid, mode of payment, etc. all are supposed to be expressly defined in the loan contract. Apart from this various legal recourse that the lender can take, in the event of default are also part of a valid loan agreement form.
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What are the different types of loan contracts?
Considering the various types of loans that can exist, there are many varied different types of loan contracts. Each type of loan agreement is specifically curated to meet the requirements of the parties. Let’s understand the three important types of loan contracts:
Personal Loan Agreement
When a person needs any money for personal reasons, it is known as a personal loan agreement. Rahul from the example above was subjected to a personal loan agreement. This type of loan contract is one of the simplest loan agreement forms.
Commercial Loan Agreement
When someone enters into a loan agreement for non-personal business reasons, a commercial loan contract applies to them. Commercial loan contracts are usually the most complex out of all loan contract forms. Here, complex details are based on many factors of the loan. For example, whether the charge on interest will be floating or fixed, etc.
A promissory note is a very specific type of loan contract. It is a note signed by the borrower in favor of the creditor, where they promise to repay a certain amount. This is the most simple type of loan contract, used by private lenders such as nonbanking financial institutions, etc. Promissory notes are suitable for short-term unsecured credit loans.
What are the benefits of a loan agreement?
The following are the benefits of having a written loan contract:
- It formalizes the entire credit transaction;
- Acts as proof that the loan amount given was a credit, not a gift;
- Protects the interest of both parties;
- Allows a recourse in case of default; and lastly
- Its legal enforceability helps in mitigating future risks.
When does a loan agreement become legally valid and enforceable?
All different types of contracts of loan become legally valid and enforceable after following these steps:
- Drafting it per the Indian Contracts Act, of 1872;
- Both parties review the agreement;
- Print it on a non-judicial stamp paper of appropriate value; and
- Signing by both parties on each page of the agreement.
If you are looking to enter a legally enforceable contract of loan, feel free to contact LegalWiz.in experts.
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