What is a Loan Agreement?

Few people sail through life without borrowing.

With few exceptions, almost everyone takes a loan to buy a car, finance a home purchase,
pay for a college education or cover a medical emergency. Loans are nearly ubiquitous and
so are the agreements that guarantee their repayment.

Loan agreements are binding contracts between two or more parties to formalize a loan
process. There are many types of loan agreements, ranging from simple promissory notes
between friends and family members to more detailed contracts like mortgages, auto loans,
credit card and short- or long-term payday advance loans.

Simple loan agreements can be little more than short letters spelling out how long a
borrower has to pay back money and what interest might be added to the principal. Others,
like mortgages, are elaborate documents that are filed as public records and allow lenders
to repossess the borrower’s property if the loan isn’t repaid as agreed.

Each type of loan agreement and its conditions for repayment are governed by both state
and federal guidelines designed to prevent illegal or excessive interest rate on repayment.

Loan agreements typically include covenants, value of collateral involved, guarantees,

interest rate terms and the duration over which it must be repaid. Default terms should be
clearly detailed to avoid confusion or potential legal court action. In case of default, terms of
collection of the outstanding debt should clearly specify the costs involved in collecting the
debt. This also applies to parties using promissory notes as well.
Purpose of a Loan Agreement
The main purpose of a loan contract is to define what the parties involved are agreeing to,
what responsibilities each party has and for how long the agreement will last. A loan
agreement should be in compliance with state and federal regulations, which will protect
both lender and borrower should either side fail to honor the agreement. Terms of the loan
contract and which state or federal laws govern the performance obligations required by
both parties, will differ depending upon the loan type.

Most loan contracts define clearly how the proceeds will be used. There is no distinction
made in law as to the type of loan made for a new home, a car, how to pay off new or old
debt, or how binding the terms are. The signed loan contract is proof that the borrower and
the lender have a commitment that funds will be used for a specified purpose, how the loan
will be paid back and at what amortization rate. If the money is not used for the specified
purpose, it should be paid back to the lender immediately.