Personal Loan Types and Repayment Options: Lenders on 02/16/2011

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If you are lending to a friend or family member, a legally binding loan agreement is a must. Creating one could be a little confusing, particularly if you are a novice lender. At LoanBack, we offer an easy wizard to walk you through building your loan contract. Before you jump in, let’s explain a couple of the terms and concepts you will see in the wizard.

Loan Repayment Options

There are several repayment options for a personal loan. When building your loan agreement, select the repayment option that works best for you and your borrower.

Amortizing Loan

The most common loan type, an amortizing loan, includes a portion of interest and principal in every payment. By the end of the amortization period, the loan balance equals zero. Lenders may prefer this type of loan for the larger, steady repayment it provides.

Interest-only Loan

In an interest-only loan, the regular payments are only the current interest. The principal of the loan is repaid in a lump sum at the end of the loan period. This type of loan is often sought when a borrower cannot afford regular payments on principal or believes they can refinance the principal with another loan at the end of the term. As a lender, be cautious and realistic. Be sure there is good reason to believe your borrow will be able to repay the principal before agreeing to this type of loan.

Balloon Payment Loan

A balloon payment loan is risky. The borrower does not make any payments during the loan term. At the term’s end, the borrower pays all the accrued interest and underlying principal in lump sum. Like an interest-only loan, the balloon payment loan can work when the borrower does not have enough income to cover amortizing payments or believes they can refinance the principal with another loan at the end of the term. But as a lender, think hard before agreeing to this type of loan.

Loan Collateral Options

If possible, a lender should always ask for collateral, also called loan security. Collateral is an asset or assets that will be transferred to you if the borrow cannot repay the loan, and it will give you peace of mind and the borrower added motivation.

Collateral should be appropriate to the loan amount and purpose. If the loan is used to purchase some physical item (e.g. car, boat, home) it is easy to determine the appropriate collateral: the item that was purchased with the loan. In some cases, like a debt consolidation loan, there is no obvious collateral. In this case, you may ask the borrower to offer some other asset, like their car or a piece of jewelry, as collateral.

Loan Covenant Options

Loan covenants—the conditions or rules a borrower must comply with over the loan term—are excellent way to spell out any special rules and avoid misunderstandings. If the borrower fails to comply with a covenant, the lender can immediately request repayment of the loan. Some of the most common covenants include:

Late Fees

A late fee clause covers any penalties the borrower must pay if a regular payment is late.

Demand Notice

A demand notice allows the lender to “demand” repayment of the loan with some advance notice. For example, a demand clause may state the lender has the right to demand repayment within 30 days of the notice.

Asset Sale/Change of Control

Under this clause, the lender may demand immediate repayment if the borrower sells the asset purchased using the loan. For example, if the loan is used to purchase a car and the borrower sells the car, the lender can demand repayment of the loan.

Financial Reporting

A financial reporting clause is most commonly included in small business loans. In this case, the lender can require the borrower provide regular reports on the health of the business or share year-end tax statements. This type of clause can also be included in personal loans, although many borrowers view this type of requirement as too invasive.

Debt Restrictions

A debt restriction clause restricts a borrower from taking on any additional debt without the lenders permission.

More Information
Lending Glossary –
What is a loan covenant? –