Loan agreement

A loan agreement is created when a lender agrees to lend money to a borrower. It acts as an enforceable contract between the parties where the borrower must pay back the lender according to the terms set out in the agreement.

When is a loan agreement used?

A loan agreement can be used when an individual or business lends money to another individual or business and a written payment plan is required.

Creating your payment plan

The payment plan you choose to adopt in your loan agreement depends on how the borrower will make payments. There are typically four options:

• Lump sum payment at the end of the term: the borrower pays the entire amount back in one lump sum on a specified date or upon demand.
• Regular payments: the lender specifies the amount and interval they wish to receive payments from the borrower. Any remaining balance is paid at the end of the term.
• Regular payments towards principal and interest: if the money is lent on a rate of interest, the lender can choose for the borrower to make regular payments that go towards the principal, as well as the interest as it accrues. There will be no large payment at the end of the term as the payment amount is calculated to pay off the principal and the interest by the end of the term.
• Regular payments only towards interest: the borrower pays instalments towards the interest only, and pays the principal amount back at the end of the term.

What is interest?

Interest is usually a percentage of the principal amount. It is charged on the outstanding amount owed to make up for the cost of inflation as well as to reimburse the lender for the risk and opportunity cost of lending it.

Caution!

Before lending money to a third party, always carry out due diligence checks to be sure that they they’re able to pay back the loan.  Use a recognised credit reference agency to do this as well as carry out a search at Companies House (if they’re a limited company).  Additionally you’ll want suitable reference from their bank, suppliers, landlord etc.