When to Use a Loan Agreement Letter
Most people borrow money or take out a loan at some point in their life. A car loan, a mortgage to finance a home purchase, a student loan to cover tuition and other education fees, or a short-term bank loan to cover any number of planned or unexpected expenses, we all borrow money at some point.
The truth is loans are everywhere, and so are loan repayment agreements. While most people are familiar with more detailed loan contracts, such as mortgages, credit card agreements, and auto loans, there is some confusion when it comes to basic loan agreement letters.
To help clear things up, we are going to explain when you should use a loan agreement letter and describe how they work.
What is a Loan Agreement Letter
A loan agreement, also referred to as a loan contract, is a binding contract documenting a financial agreement between two or more parties. The party who writes the loan agreement letter is the lender, and the other party is the borrower. Both parties must agree to the terms and sign the letter for it to be binding.
The loan agreement letter doesn’t only act as binding proof of the arrangement, but it also details the terms of the loan. When written correctly, a loan agreement letter specifies the interest rate, repayment plan, and payment dates. The agreement spells out this information, detailing the conditions of the loan and making sure that both the lender and the borrower understand the arrangement.
A loan agreement letter complies with both state and federal regulations to ensure that the lender and borrower are both protected should either party fail to honor the agreement.
Once the loan agreement is written and agreed upon by the lender and the borrower, both parties sign it. A signed loan agreement letter is proof that the borrower and lender have committed to the exchange of funds and repayment of the loan term.
Using a Loan Agreement Letter for a Specific Type of Loan
Most loan agreement letters specify the purpose of the loan to make sure that the borrower borrowed the money in good faith. If the borrower does not use the loan for the pre-defined purpose, they should pay back the lender immediately.
When to Use a Loan Agreement Letter
As mentioned, many loan agreements involve detailed contracts written by financial institutions and professional lenders. Mortgages, auto loans, student loans, and credit cards usually involve signing a lengthy written contract, but many types of agreements fall outside of the boundaries of these more recognized agreements.
Borrowing money can be a messy process, even when it is amongst family and friends. Not only can the amount represent a large financial commitment, but outstanding loan payments can also quickly wear on relationships and eventually lead to legal disputes.
A formal loan agreement is necessary for both parties that ensure that the terms are agreed upon before any money changes hands.
Loan agreement letters are useful in the following situations:
- Business to Business Loans – When one business lends money to another, there a loan agreement protects both parties. For example, if a bank wants to loan
- A loan agreement letter protects both parties if the matter ends up in court. The signed loan agreement can resolve legal issues quickly and decisively.
- Loan agreement letters detail repayment dates, so one party can not falsely accuse the other of not living up to the agreed-upon terms of the loan.
As you can see, writing and signing a loan agreement letter protects both the lender and the borrower. Remember, you do not have to hire a lawyer to have a legally binding loan agreement letter. Save yourself time and frustration by always using a loan agreement letter when lending or borrowing money to a small business or startup company, both parties are legally and financially protected if they sign a loan agreement first.
- Business to Individual Loans – When a business loans money to an individual borrower, a loan agreement is imperative. Whether an individual takes out a personal loan from a bank or borrows money to purchase a property from a real estate lender, a loan agreement must be signed ahead of time.
- Individual to Individual Loans – When someone agrees to privately loan money to another person, both parties should sign a loan agreement. While financial transactions between family members and close friends might seem informal, they can lead to serious legal disputes if one party feels they have been wronged. This is why it’s important to sign a loan agreement letter when money is loaned instead of gifted.
Other Reasons Why You Should Use a Loan Agreement Letter
Borrowing money is a financial commitment that strains the relationship between two parties if one feels the other is not living up to their side of the arrangement. Loan agreement letters clarify the nature of the loan and the conditions that go with it, helping to prevent either party from feeling aggrieved.
While most of the terms and conditions in a loan agreement letter are fairly straightforward – amount, interest, repayment plan, collateral, late fees, and default penalties – here are some other reasons why lenders and borrowers should sign a loan agreement letter:
- It is legal proof that the money was a loan, not a gift. It is essential to clarify this with a loan agreement for tax purposes, and it helps prevent confusion in the future if the borrower later claims they did not realize they had to pay the money back. This is particularly important when the loan is between family members.
- A loan agreement letter protects both parties if the matter ends up in court. The signed loan agreement can resolve legal issues quickly and decisively.
- Loan agreement letters detail repayment dates, so one party can not falsely accuse the other of not living up to the agreed-upon terms of the loan.
As you can see, writing and signing a loan agreement letter protects both the lender and the borrower. Remember, you do not have to hire a lawyer to have a legally binding loan agreement letter. Save yourself time and frustration by always using a loan agreement letter when lending or borrowing money.