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Understanding a Business Loan Agreement

Borrowers and creditors are bound by the terms and conditions outlined in the business loan agreement. The loan agreement aims to safeguard all parties by outlining their respective responsibilities and rights.

When making loans, conventional banks and non-bank, alternative creditors both use standard loan agreement templates. Any time you borrow money for a business purpose, such as opening up a shop, buying an existing one, or investing in machinery and supplies, you will need to sign a business loan agreement.

After you have completed the loan application procedure, underwriting, and received an offer, you will need to sign a business loan agreement. But before you put your name on anything, you should read up on what it is you’re agreeing to.

What Exactly Is a Business Loan Agreement?

A business loan agreement contains all the information a debtor needs to know about the specifics of the debt the company is taking on. Always read the fine print of a business loan before signing your name. If you don’t do your research, you can be getting a company loan with terms you don’t understand.

A business loan is very similar to a personal loan other than the purpose for which the money is being borrowed. Loans continue to rely on the trust between a creditor who provides capital and a debtor who accepts that capital on the assurance that it will be repaid, with interest. A loan agreement, whether for a business purpose or otherwise, specifies the amount borrowed, the repayment schedule, and any interest or other fees associated with the loan (interest rates, fees, etc.).

Below are just a few of the most essential items to keep an eye out for in any business loan arrangement.

How Does a Business Loan Agreement Work?

A company may need to apply for a loan multiple times over its existence. Some scenarios where a company might need a loan are:

  • Entering the startup phase
  • Investing in a new structure
  • Investing in Tools and Vehicles for the Business
  • Purchasing goods or components for the purpose of building up an inventory
  • Use the creditor’s standard loan application, loan agreement, and supporting paperwork when applying for a business loan. An individual private loan may entice you to skimp and utilize a sample or a freely available form instead of creating your own unique arrangement.

In most cases, the creditor will offer a business loan agreement, especially when dealing with traditional lending organizations like banks, credit unions, and the like. If a business owner obtains a loan from a private individual, however, that individual may require the debtor to sign a separate agreement.

What Is Included in a Business Loan Agreement?

Listed below are the main components of a business loan agreement. Learn the process from beginning to end to prevent any unpleasant surprises.

  • Promissory note – An IOU, loan agreement, or promissory note can all serve the same purpose. A promissory note is a legal document in which a debtor pledges to return the money borrowed from a creditor within a set period of time. This type of document provides a binding legal obligation to repay the debt and is legally binding.
  • Security agreement – To secure a loan, debtors are often required to pledge personal or business assets. To put your collateral on the line for a loan, you’ll need to sign a security agreement. A thorough security agreement will specify in great detail which assets are being used as security.
  • Rate of interest – The price of borrowing money is expressed as a percentage of the loaned sum and is known as the interest rate. There are two types of interest rates: variable and fixed. Loan to value ratio, debtor’s credit history, and loan security all play a role in determining the interest rate.
  • Affirming statements – You, the debtor, will be required to confirm a number of facts. The ability to repay the loan, the veracity and accuracy of the company’s financial statements, and the absence of any liens or lawsuits that could impair the company’s ability to repay the loan are just some examples of the kinds of representations you may be asked to make.
  • Personal guarantee – When you sign a personal guarantee for a company loan, you give the creditor permission to seize and sell your personal assets to cover the loan’s repayment in the event that the firm defaults on its loan payments. Your house, car, savings, and retirement funds are all examples of personal assets.
  • Prepayment penalty – Creditors may impose a charge known as a prepayment penalty on debtors who pay off their loans before their terms are up. The term of a loan is the amount of time it is expected to take for the debtor to repay the loan in full.
  • Late payment penalty – Your small company loan arrangement will certainly include the customary late payment penalty. If you’re late on a payment, you may have to pay a flat rate or a percentage of the total due. Pay your bills on time to avoid this charge.

Terms to Be Aware of in Business Loan Agreements

Legal jargon in business loan agreements might make them seem foreign. Understanding common terminology can help interpret contracts. Before signing a loan, know these terms:

  • Loan Amortization – schedules equal payments over the loan’s payback term. Each payment includes principle and interest.
  • Annual Percentage Rate (APR) – is the annualized cost of borrowing, including interest and fees.
  • Automated clearing house (ACH) – ACH payments are a sort of business loan payment made by automatic bank withdrawals.
  • Balloon Payment – Term loan payments include interest and principal. The principal is repaid over the loan’s term. Some loans are arranged so that all or part of the loan principal must be repaid as a single balloon payment.
  • Blanket lien – protects all of a company’s assets, not just one. If the debtor defaults, the creditor can attach any of the debtor’s assets to reclaim the loan sum.
  • Co-signer – boost a debtor’s loan approval chances by agreeing to repay the loan if the principal debtor defaults. The loan contract specifies the co-responsibilities, and signers if appropriate.
  • Curtailment – is when a debtor pays more than the monthly payment required by the loan arrangement. A partial curtailment is when the debtor makes extra payments but doesn’t pay off the debt; a full curtailment involves paying off the loan.
  • Default – When debtors don’t make loan installments as agreed, they default. If a debtor defaults, the creditor can sue the debtor or co-signer to recover the loan sum.
  • Deferred-payment loan – the creditor and debtor agree that payments start at a future date, not immediately.
  • Factor rate – Invoice factoring and merchant cash advances feature factor rates instead of interest rates. Factor rates are expressed as a decimal that indicates the total loan amount that will be repaid. If a loan’s factor rate is 1.2, the debtor will repay $12,000.
  • Interest-only payment loan – covers only interest, not the principle. The loan principle is repaid or refinanced after the term ends.
  • Loan-to-value (LTV) ratio – measures how much of an asset’s value a loan covers. This is important for firms buying equipment or property.
  • Underwriting – evaluates a debtor’s risk to a creditor.
  • Prepayment penalty – Because creditors expect interest to accrue over the loan duration, early repayment can result in lost funds. Prepayment penalties offset this loss.
  • Principal – is the amount a company borrows, excluding interest. Each loan payment includes interest and principal.
  • Refinancing – entails getting a loan to pay off another. Refinancing can cut interest rates or monthly loan payments.
  • Servicing – refers to the management of a loan, including disbursement, collection, and delinquency.

What to Avoid in a Business Loan Agreement?

It’s crucial to give some thought to doubts about the creditor that might arise when you read through your loan agreement. With company loans, even the slightest of facts might raise red flags.

Let’s go over some worst-case scenarios that should give you pause before signing that business loan agreement:

  • Asking for payment in advance – Creditors who demand security or advance payments should raise red flags. A request for a one-time, up-front payment is indicative of shady tactics, regardless of the reason given (credit check, application fee, brokering cost, etc.).
  • Guaranteeing your approval – A red flag should go up if a creditor offers you a loan without first verifying the legitimacy of your firm. It’s possible you’re about to fall for a loan scam if your first point of contact with the creditor was a guaranteed offer.
  • Approaches to selling with a lot of pressure – Did somebody make you feel obligated to take out this loan? If you’ve gotten this far, it may be because you felt you had no choice but to agree. Think about whether or not you’re prepared to take on debt under the terms of the business loan arrangement. To avoid signing if you don’t agree, just say no.
  • Terms that are too good to be true – The last thing you need to know is that if the terms of the business loan deal you’re signing seem too good to be true, it’s because they probably are.

Bottom Line

Find a creditor with excellent service quality and cooperate with them. Your creditor should be easy to get in touch with in whichever way is most convenient for you, whether that’s via email, phone, or live chat, as you’ll likely have questions throughout the process. Online review sites where past debtors share their experiences with prospective debtors are a great resource for this.

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