It is becoming ever more popular for people to loan money to friends or loved ones. This could be to assist someone in buying anything from equipment for their line of work, to a new home. Case law suggests that 'by way of a business' includes factors such as whether there were frequent substantial loans being made, whether the loans were made in order to generate profit and what relationship there is between lender and borrower.
If you are considering making a loan to a family member or a friend, we would recommend that you seek legal advice before doing so, to ensure that you are complying with the relevant legislation. The Commercial Team at Frettens also advises on loan agreements generally so can offer all of the advice in one place. A secured loan is where the money that was loaned is secured by placing a charge over an asset usually belonging to the borrower , where the charged asset acts as collateral should the borrower default on the loan.
This gives the lender comfort in knowing that if the borrower is unable to repay the debt, this can potentially be recovered from elsewhere. It is often the case that some form of security will be required by the lender, particularly where a company borrowing funds is newly incorporated. Security can take many different forms. For example, if you are lending to a company, you might consider asking the directors of the company to personally guarantee the payment obligations of the company under the loan agreement.
This way, you know that if the company were to be wound up, you could look to the directors personally to repay the loan. Another option would be to obtain a debenture similar to a legal charge over the company itself.
For loans to individuals, a loan can be secured against assets such as property belonging to the borrower. This would essentially take the form of a mortgage, which would be documented as a legal charge and registered against the property at the land registry. The registered charge would then give the lender a proprietary interest in the property and if the property was subsequently sold, the lender would have a first right over any sale proceeds needed to repay the loan.
In some cases where a borrower defaults on repayment of a loan, a legal charge can be used to force a sale of property. A well drafted loan agreement and legal charge should always be considered by parents wishing to lend money to their children to provide security that if their child should marry in the future, those sums do not form part of any subsequent divorce settlement. A legal charge can be placed on the property so that if the property is sold for any reason such as in divorce proceedings , the loan is returned to the parents first.
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A loan agreement is a document, signed by both the lender and the borrower, that spells out the terms of the loan. These agreements are binding and can be simple or complex. The loan agreement lays out the repayment schedule, the costs to the borrower, and other rules or requirements. Loan agreements must follow state and federal guidelines to protect the borrower from excessive interest rates or loan fees. Key takeaway: A loan agreement spells out the details of the loan, including the amount, interest, and terms.
A loan agreement is an extremely important part of borrowing money. Without one, neither party is protected if they run afoul of the loan terms.
There are several reasons why you need a loan agreement:. Key takeaway: A loan agreement removes any ambiguity about the loan, protects both parties from hiked fees or missed payments, shows the IRS that the money isn't a gift, and helps you negotiate.
Beyond the borrower information and transaction details, loan agreements include the lender's expectations of the borrower, which are broken down into positive covenants, negative covenants, and reporting requirements, according to Kakebeen. These three sections outline everything the borrower can and can't do, and they provide a framework for annual or quarterly reporting habits.
These sections, and the section detailing defaults, are the areas you should scrutinize before you sign. Loan terms can apply to aspects such as changing ownership even if the business is being passed on to a family member or business insurance , or making the lender your primary bank for the duration of the loan.
Some terms even extend beyond the primary company to its subsidiaries, according to Wolfe. Getting a small business loan means ironing out exactly what you need to do to stay compliant with your lender's terms. This allows you to get the loan that best fits your business's needs and to build a relationship with your lender. Key takeaway: When you're reviewing the contract terms of the loan agreement, pay attention to the lender's expectations, including the positive covenants, negative covenants, and reporting requirements.
The reporting requirements section outlines the financial reporting required of the borrower. You may be tempted to overlook this section. However, it's important to read and understand everything, Kakebeen said. For example, the reporting requirements outline when and how to submit the loan documentation. Pay attention to the quality of this documentation as well, he said, as there's a big difference between a company-prepared financial statement and a fully audited financial statement.
If you fail to meet certain reporting requirements, the bank can recall the loan, which means you'll enter the default process. Kakebeen said the purpose of these requirements is to provide a look into your cash flow and operations, which sheds light on debt-service coverage ratios and other important financial indicators. The documentation also allows the lender to keep an eye on your business as it grows and changes. Don't assume that this process is finished once the lender has approved the loan, Kakebeen said; in some instances, your lending officer may ask for additional information and financial documentation.
One metric the financial reporting reveals to the lender is whether you're maintaining the correct debt-service coverage ratio DSCR , or a company's ability to meet its current debt obligations based on its cash flow. These ratios are outlined in the loan agreement, usually in the positive covenants section, according to Wolfe. While decreased sales obviously affect your DSCR, it's important to be aware of other factors. If you're running a seasonal or cyclical business, for example, you'll want to talk with your lender about setting up ratios that make sense for your cash flow throughout the year.
Taxes and tax returns can have an impact on cash flow, to the point where it could push your DSCR below the lender's limit, Kakebeen said. This is another indirect way you might violate the loan agreement. Key takeaway: Lenders require you to maintain a certain debt-service coverage ratio throughout the life of the loan.
If it falls below the agreed-upon ratio, you've violated the loan terms. Prepayment penalties are fees the lender charges the borrower for paying off the loan before the end of the term originally set in the loan agreement. Prepayment penalties are usually outlined in the positive or negative covenants sections or have their own section. These fees may feel like a punishment when you've only honored your pledge to repay the loan.
However, prepayment penalties often protect lenders. This is important because it details when the loan agreement is active and will prevent you from having to travel to another place if there are any disputes or nonpayment on the agreement.
Once you have the information about the people involved in the loan agreement, you will need to outline the specifics surrounding the loan including the transaction information, payment information, and interest information. In the transaction section, you will detail the exact amount that will be owed to the lender once the agreement has been executed.
The amount will not include any interest that will accrue during the lifetime of the loan. You will also detail what the borrower is getting in return for this sum of money that they are promising to pay to the lender. In the payment section, you will detail how the loan amount will be repaid, the frequency of the payments e. You will need to include exactly what you will accept as a form of payment so there is no question on the forms of payment allowed. In the interest section, you will include information for any interest.
If you are not charging interest, then you will not need to include this section. However, if you are, you will need to detail the date when the interest on the loan will begin to accrue and whether the interest will be simple or compound in nature. Simple interest is calculated on the unpaid principal amount while compound interest is calculated on the unpaid principal and any interest that is unpaid.
Another aspect of interest you will need to detail is if you will have a fixed or variable rate of interest. A fixed rate interest loan means that the interest rate will stay the same during the lifetime of the loan, whereas a variable rate loan means that the interest rate can change over time based on certain factors or events. You may also want to include information about prepayment in case the borrower is interested in paying the loan off early.
Many borrowers are concerned about prepayment and you would be wise to include a clause in your loan agreement that talks about prepayment options, if any.
If you are allowing prepayment, you will need to include this information and detail if they are allowed to prepay the entire amount or only a partial amount, and if you will be requiring a prepayment fee if they choose to do so. If you are requiring a prepayment fee, you will need to detail how much that will be. Traditionally, lenders require that a percentage of the principal is paid early before they can pay the remaining balance. If you are not allowing prepayment, then you will need to detail that it is not allowed unless written permission is provided by you, the lender.
You have the option of requiring collateral in exchange for your loan. If you wish to do this, then you need to make sure you include sections that address this. For collateral, if you are requiring it to secure the loan, you will need to have a specific section. Collateral would be an asset that is used as a guarantee of repayment. Examples of assets that can be used include real estate, vehicles, or other valuable goods.
If you are requiring collateral, you will need to identify all collateral that is needed to secure the agreement. Another section you need for this is one regarding the security agreement. If you are not requiring collateral, then you can omit this from your loan agreement. In regard to the collateral, if each party is signing a separate security agreement for it, then you will need to include the date that the security agreement is signed, or will be signed, by each party.
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