When you take out a loan, you sign a loan agreement with your lender. This contract explains the conditions of your loan in detail.
Before you sign, it’s important to review your loan agreement carefully. It will tell you exactly what your obligations are. You should also compare loan agreements from different lenders to help you find the best loan for your situation.
- A loan agreement is a contract that explains all the conditions of your loan. It also tells you what will happen if you miss a payment or have a legal dispute with your lender.
- By reviewing your loan agreement carefully, you’ll know what your loan costs, what it can be used for, and how and when it must be repaid.
- Comparing loan agreements from different lenders will help you choose the most affordable loan.
Below, we’ll explain what you need to know about loan agreements.
Here’s what we’re going to cover:
- What is a loan agreement?
- What information is in a loan agreement?
- Seven important clauses to review in a loan agreement
- Oportun: Affordable personal and secured personal loans
What is a loan agreement?
When you borrow money from a friend or family member, you usually make a verbal agreement with them. Maybe they agree to lend you $100 and you promise to pay them back by the end of the month. Since you know each other, you trust each other to keep your promises.
Because lenders don’t know you personally and they need to be assured they’ll be repaid, they ask you to sign a contract where you formally agree to all the loan’s conditions.
Loan agreements are legally binding. Before you sign one, it’s important to review all the information in it carefully. This helps you make the best decision about a loan offer for your financial situation.
What information is in a loan agreement?
Your personal loan agreement explains the conditions of your loan. These generally include:
- The principal (the amount of money you’re borrowing)
- How you can use your loan
- The loan term (the amount of time you have to pay back what you borrow)
- Your loan’s interest rate, fees, and annual percentage rate (APR)
- If collateral is required
- Your payment amount, schedule, and method
- What happens if you miss a payment
- How you and your lender can resolve any legal disputes
Because this information is clearly stated in the loan agreement, both you and your lender know exactly what the loan’s conditions are. If you have any questions, be sure to ask the lender before you sign an agreement.
Seven important clauses to review in a loan agreement
Now we’re going to review the specific things you’ll want to look at in a loan agreement. If you don’t feel comfortable with any of the conditions listed, you may want to choose a different lender.
1. Acceptable uses
First, it’s a good idea to make sure you can use the loan for your intended purpose. Many loans can only be used for one purpose. For example, an auto loan can only be used to buy a car.
Some other types of loans may be more flexible. Most personal loans can be used for any of the following:
- Medical bills
- Home improvements
- Car repairs
- Unexpected expenses
- Paying back friends and family
- Debt consolidation
Personal loans have some restrictions too. For instance, you can’t use a personal loan to pay for expenses related to business or education. You’ll want to know all the restrictions of your loan before signing the loan agreement.
2. Interest rate
Your interest rate is the cost you will pay each year to borrow money expressed as a percentage rate. It does not reflect fees or other charges you may have to pay for the loan. Generally the lower your interest rate, the less expensive your loan is. And you’ll usually qualify for a lower interest rate if you have a high credit score.
What is a credit score?
- Your credit score is a number between 300 and 850 that gives businesses an idea of how likely you are to make payments on time.
Interest rates can be fixed or variable. Fixed interest rates stay the same over the entire period of your loan. With a fixed interest rate, you know exactly how much you’ll have to pay in interest. Variable interest rates can go up or down throughout your loan term. You won’t know ahead of time how much interest you’ll be paying.
Most lenders charge fees to cover part of their costs. The amount you pay in fees can vary greatly from one lender to another. Loan fees may include:
- Application fees
- Underwriting fees
- Origination fees
- Document fees
- Legal fees
- Processing fees
- Prepayment penalties (for paying off the loan early)
If the fees listed in your loan agreement are very high, you may want to look for loan company with lower fees.
4. Annual percentage rate (APR)
You’ll want to pay close attention to the APR offered by each lender. APR tells you the total annual cost of borrowing money. It includes interest as well as any fees for taking out the loan.
APR is the best measurement for comparing the cost of loans from different lenders. All lenders are required to clearly state the APR in the loan agreement, thanks to the Truth in Lending Act.
Some loans require you to put up collateral. Collateral is something of value that you promise to give your lender if you fail to make your loan payments on time. Your home, your car are typical examples of collateral.
If your loan requires collateral, the loan agreement should tell you:
- The minimum value of the collateral
- What assets can be used as collateral
- How soon after a missed payment your lender can take the collateral
Since collateral involves your personal belongings, you’ll want to know exactly what could happen to it if you miss a payment.
6. Repayment conditions
As a borrower, you have a responsibility to pay back the loan according to the conditions of the loan agreement.
If you don’t repay your loan, you could face these consequences:
- A decrease in your credit score
- The loss of your collateral
- Calls from collection agencies
- Being taken to court
Understanding the loan’s repayment conditions will make it easier to repay your loan correctly and on time. Here are some of the most important things to know.
Repayment schedule. The repayment schedule tells you how frequently you have to make loan payments. Most personal loans require one payment a month. Some require two payments a month.
Payment amount. This tells you exactly how much each of your loan payments will be. Make sure the payments will fit into your budget. If the payment amount is too high to manage comfortably, you may want to look for a loan with smaller payments.
Balloon payment. A balloon payment is one large payment that’s due at the very end of your loan term. Some loans require balloon payments, others don’t. If your loan calls for a balloon payment, you’ll want to know how much it is so that you can save up for it.
Payment method. There are many ways to make loan payments, including cash, credit card, debit card, wire transfer, check, or money order. Check your loan agreement to see what your lender’s preferred payment method is, and whether you can choose which method you use.
7. Mandatory arbitration
Some loan agreements have a clause about mandatory arbitration. Arbitration is a legal process that allows you and your lender to settle any disputes with the help of a third party called an arbitrator.
Arbitration is faster and cheaper than going to court. For this reason, a lender may require arbitration if there’s a dispute. Some loan agreements call for binding arbitration, which means that the arbitrator’s decision is final. You won’t be able to fight it in court if you disagree.
Oportun: Affordable personal loans with fixed payments that fit your budget
Now that you understand what to look for in a loan agreement, you’ll be able to choose the right loan with confidence. Review the agreement carefully and be sure all your questions have been answered before you sign anything.
If you’re looking for an affordable personal loan, we can help. Loans through Oportun come with:
- Low, fixed APRs of 36 percent or less (APRs vary by state)
- Affordable loan payments
- Personalized payment schedules to fit your budget
Best of all, you don’t have to have a credit history to apply for a loan through Oportun. See if you prequalify a personal loan today.
Consumer Financial Protection Bureau. What is a prepayment penalty?
Federal Trade Commission. Truth in Lending Act
Consumer Financial Protection Bureau. What is a balloon payment? When is one allowed?
The information in this site, including any third-party content and opinions, is for educational purposes only and should not be relied upon as legal, tax, or financial advice or to indicate the availability or suitability of any Oportun product or service to your unique circumstances. Contact your independent financial advisor for advice on your personal situation.