Loan agreement: Overview, definition, and example
What is a loan agreement?
A loan agreement is a formal, legally binding contract between a lender (such as a bank or financial institution) and a borrower (which could be your business or an individual). The agreement outlines the terms and conditions of the loan, including the amount borrowed, the interest rate, repayment schedule, and any collateral required to secure the loan. It also specifies the consequences of failing to meet the terms, such as penalties or default.
For example, if your small business borrows money from a bank to fund expansion, the loan agreement will define the repayment terms, interest rate, and any requirements or conditions tied to the loan.
Why is a loan agreement important?
A loan agreement is important because it sets clear expectations between the borrower and the lender. It protects both parties by defining the terms of the loan and ensures that both understand their responsibilities and the consequences of not meeting those responsibilities. For SMBs, a well-drafted loan agreement is essential to securing financing on favorable terms while providing legal protection in case of a dispute or default.
For businesses, loan agreements provide the structure and clarity necessary to ensure the timely repayment of borrowed funds and avoid misunderstandings that could lead to legal or financial issues.
Understanding loan agreement through an example
Imagine your small business needs a $50,000 loan to purchase new equipment. You approach a bank and negotiate the terms. The loan agreement outlines that you will repay the loan over 5 years at a 6% interest rate, with monthly payments starting one month after the loan is disbursed. The agreement also includes a clause requiring your business to provide collateral in the form of the purchased equipment. If your business fails to repay the loan, the bank could seize the equipment to recover its money.
In another example, a supplier might offer your business a loan to finance the purchase of materials. The loan agreement would detail how much money the supplier is lending, the interest rate, and the repayment terms, such as when payments are due and whether any penalties apply for late payments.
An example of a loan agreement in action
Here’s how a loan agreement might be referenced in a financial contract:
“The borrower agrees to repay the total loan amount of $50,000, with interest at 6% annually, in 60 monthly payments of $966.27 each. The loan is secured by the purchased equipment. Failure to make timely payments will result in a late fee of $100 and the potential for the lender to seize the collateral.”
Conclusion
A loan agreement is a formal contract that specifies the terms and conditions of a loan, including repayment schedules, interest rates, and any collateral requirements. For SMBs, understanding and negotiating loan agreements is essential to secure funding for business needs while protecting the company from financial risks and ensuring timely repayment. A clear and detailed loan agreement helps maintain good relationships with lenders and ensures that both parties are aligned on expectations.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.