If you are borrowing money from 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. 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 lender.
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. This is often the best choice for borrowers as it reduces the amount of interest that accrues over the life of the loan and breaks principal payments down into manageable portions.
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. Be cautious and realistic when considering this type of loan. Ask yourself, “If I can’t afford to make small, regular payments on principal, how will I pay for it all in the end?”
Balloon Payment Loan
A balloon payment loan is very risky. You, the borrower, won’t make any payments during the loan term. At the term’s end, you’ll have to pay the accrued interest and underlying principal in a lump sum. Think carefully before choosing this type of loan. What will change by the end of the loan term that will allow you to make this lump sum payment? Will you be selling a business or property, receiving an inheritance, or enjoying the maturation of investments? If you can’t foresee now how you will fulfill the obligations of a balloon payment loan, this is probably not the right choice for you.
Loan Collateral Options
As part of your loan contract, your lender may ask for collateral, also called loan security. Collateral is an asset or assets that will be transferred to the lender if you cannot repay the loan. While collateral may be peace of mind for your lender, it’s likely to be an additional motivating force for you, the borrower.
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), that item is the best collateral. In some cases, like a debt consolidation loan, there is no obvious collateral. In this case, you may offer some other asset, like your car or a piece of jewelry, as collateral.
Loan Covenant Options
Loan covenants are the conditions or rules you must comply with over the loan term. They are an excellent way to spell out any special rules and avoid misunderstandings. If you fail 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 you 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 you sell the asset purchased using the loan. For example, if the loan is used to purchase a car and you sell 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 you 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 - Loanback.com What is a loan covenant - LoanUniverse.com