How to Understand Your First Personal Loan Agreement

Some 19.1 million U.S. consumers have unsecured personal loans. 3.39% of these loans are in delinquent status. 

While a personal loan can help address a money shortage, an emergency, or even a big purchase, knowing you can pay the loan back is important. 

Before you sign a personal loan, you need to review every detail in the agreement to ensure you understand the expectations for you as a borrower. 

Wondering what you should expect to see in a personal loan agreement? Read on to learn more. 

What Is a Personal Loan Agreement?

When you seek a personal loan, the lender will consider your application. If they decide to lend it to you, you’ll have to sign a personal loan agreement.

This legal document outlines the specific terms and expectations related to the loan. It will spell out what the lender will loan to you.

More importantly, it spells out the lender’s expectations for the borrower. You should never enter a borrowing situation without carefully reviewing the loan agreement. 

Importance of Personal Loan Agreement

The loan agreement for a personal loan is important for both the borrower and the lender. 

This legal document is essential for the lender because it commits the borrower to repay the loan and under what terms. It also means the lender has legal recourse should the borrower not live up to their responsibility with the loan.

The loan agreement is also essential for the borrower. It creates transparency in the agreement between the two parties. The document forbids the lender from changing the terms of the agreement during the life of the loan.

The loan agreement is additionally relevant for tax purposes. It provides evidence to the IRS that the money you get is a loan, not a gift or income. This means you won’t need to pay taxes on the money.

Types of Loan Agreements

There are many different loans you might seek. For example, you might get a mortgage to buy a house or an auto loan when you buy a car. You get a student loan when you’re paying for college.  

There are essentially two types of loan agreements. 

Secured Loan

One type of loan agreement is a secured loan. For the lender to offer the loan, collateral must be attached to the loan terms. 

For example, when you get a mortgage to buy a house, it’s a secured loan. The lender agrees to lend you money to buy a house. If you default on the loan, the lender can take the house, which acts as collateral for the loan.

Unsecured Loan

Often a personal loan is an unsecured loan. This means that there is no collateral attached to the loan. 

If the borrower defaults on the unsecured loan, the lender can follow legal steps to get their money. Yet, they can take nothing from the lender when they default to make up the loan’s value. 

Typically, an unsecured loan will be for smaller amounts and come with higher interest rates than a secured loan because there’s more risk for the lender. 

Contents of a Loan Agreement

It’s good to think of the loan agreement for a personal loan as the parts that make up the legal contract between the lender and borrower. 

Again, as the borrower, it’s critical to read all the fine print and ensure you understand what you’re agreeing to when signing the loan agreement. 

Lender and Borrower Information

The loan agreement will have all the lender and borrower information for legal purposes. This will include:

• Names of both parties
• Addresses
• Phone numbers
• Social security numbers for borrowers

This is identifier information for the parties entering into the agreement. 

Interest Rates

The loan agreement will list the interest rate the borrower agrees to pay on the money they’re borrowing. 

This number is important to borrowers because it helps calculate how they’ll pay above and beyond the loan amount. 

You can expect slightly higher interest rates for those with lower credit scores. Also, remember unsecured loans tend to have higher interest rates because there’s more risk for the lender. 

Repayment Timeline

The repayment timeline is the amount of time the borrower has to repay the loan. 

Personal loans are unsecured and tend to have shorter repayment timelines for smaller amounts. 

The repayment timeline is one thing you can negotiate with the lender. The longer you take to repay a loan, the more interest you’ll pay. But longer repayment timelines also mean lower payments. 

Repayment Method

The repayment method spells out how the borrower should pay the loan. 

In most cases, the borrower makes monthly payments towards the principal and interest for a personal loan. 

It will spell out how to make a payment on the loan.

Late or Missed Payments

Your loan agreement should spell out the consequences of making a late payment or missing a payment. 

Of course, you want to avoid this, but you should also know what will happen if you pay late. 

In most cases, you’ll be charged a late fee that will be tacked onto the loan balance. If you pay more than 30 days late, the lender will usually also report to the credit agencies. 

Fees

Most personal loans will come with some fees to secure the loan. These are often called origination fees that also get added to the loan’s value. 

Some origination fees are a flat rate for securing the loan. Other times the origination fee will be a percentage of the loan amount. 

Principal

The principal is the actual amount the borrower is getting for the loan. All fees and interest get added to the principal value of the loan to calculate your monthly payments. 

As a borrower, you must remember that you’ll be paying the lender back much more than the principal amount. 

APR

To get the most accurate picture of what a loan will cost the borrower, they should look at the APR or the annual percentage rate. 

The APR on a loan includes the principal amount, interest, and any fees connected to the loan.

It also helps to explain how the interest connected to the loan will be calculated. 

Default Conditions

Some personal loan agreements will include language that explains the default conditions for the loan. This means it will explain precisely what the lender will do if the borrower defaults on the loan. 

In many cases, there will be a clause that states the accelerated payment of the loan balance is due if there’s a default on the loan.

Important Questions to Get Answered Before Signing a Personal Loan Agreement

As a borrower, you want a successful outcome from a personal loan. Before you consider taking out a loan, there are some essential questions to consider. 

Do You Need All the Principal You’re Borrowing?

Before you take out any type of loan, you should carefully consider your needs. You might qualify for more than you actually need when you get the loan. 

While getting a bigger loan can be tempting, you must remember that any amount you borrow will cost you interest. 

You should only borrow what you need.

How Long Do You Have to Pay Back the Loan?

Loan terms can vary for repayment. You want to consider how long you’ll have to work in the payment into your budget. 

Again, extending the loan any longer than necessary doesn’t make sense since it will only cost more in interest. 

Are There Any Penalties for Early Repayment?

Some people will take out a personal loan when facing an emergency. You might calculate how long you need to repay it.

Some people find they get back on their feet and want to repay the loan early. Sometimes, some lenders will charge you more for early repayment of the loan. 

The lender bases their calculations on what they’ll make in interest. It might not be in their best interest to let you back the loan lump sum early without penalty. 

Is the Monthly Payment Affordable?

Of the many loan mistakes you could make, not preparing for the monthly payment is big. 

You can end up in more financial turmoil when you borrow a loan you can’t afford to pay back. Take a closer look at your monthly budget to ensure you can afford those payments. 

What Factors Contributed to the Interest Rate?

You need to know what interest rate you’ll get charged for your personal loan. 

It’s also important to understand what impacts the interest rate you’re being charged. 

Lower credit scores will pay more for a loan than those borrowers with credit scores. 

Understanding Your Personal Loan Agreement

Before you sign a personal loan agreement as a borrower, you must understand the loan terms. It’s important to know what a personal loan will actually cost you. 

If you’re interested in learning more about personal loans and want to know what you qualify for, check out our site for more personal loan information.