Talking about money can be very difficult, especially if it involves borrowing or lending considerable amounts of it.
However, if you have a project in mind that costs more than your personal savings can cover, you might need to strike a deal to get the funding you need. Whether you do that with family, friends, or a professional lender, shaking hands and then speaking as little of it as possible just won’t suffice.
In this article, we define what a loan agreement is and why it’s important to have one when you require additional money or capital.
What is a loan agreement?
A loan agreement is a legal document under which one party (the lender) gives funds to another party (the borrower). It can be a loan from a friend, family or institution. Loan agreements may be covered by the National Consumer Credit Protection Act (2009) (‘the Act’), which includes the National Credit Code. More specifically, the Act might apply if:
1. the borrower or debtor is a natural person or a strata corporation;
2. the credit is provided wholly or predominantly:
a) for personal, domestic or household purposes; or
b) to purchase, renovate, or improve residential property for investment purposes; or
c) to refinance credit that has been provided for the above purposes;
3. a charge is or may be made for providing the credit; and
4. the lender is in the business of extending credit to individuals and business entities.
What are the types of loans offered in Australia?
Depending on your circumstances, you may be able to apply for the following loans:
1. Loans in general
Commonly, there are two kinds of loans – secured and unsecured. Secured personal loans are those that require collateral to be put up as security, which must be something valuable that you own such as your house or your car. In the event you fail to settle the debt, the lender can usually apply to seize the collateral as a payment towards the debt owed. Car loans and mortgages are common examples of a secured loan.
On the other hand, unsecured loans do not require collateral/security and for this reason, ordinarily attract higher interest rates. Unsecured loans are often provided based on your credit score, ability to repay the debt, potentially your net asset position and debt repayment history. Credit cards and personal loans are common examples of unsecured loans.
2. Short term loan
This type of loan may cover temporary cash flow or funding issues, whether personal or business-related. In recent years, short-term loans have been far more accessible, with a lot of online entities providing various options. Short term loans are exactly as the name suggests, loans that are intended to be repaid in a short period of time, commonly within 24 months.
This is commonly linked to an existing transaction or business account and allows you to withdraw additional funds when your balance reaches zero. Monthly or annual fees apply on some overdrafts; however, interest is ordinarily only charged on the overdraft funds used.
4. Line of credit or loan facility
This option is usually where a specific amount is approved for the purposes of say, a building project, allowing you to draw down on the credit up to the specific amount approved. Whilst a certain amount might be approved under a loan facility arrangement, this does not mean that the borrower needs all the approved funds and they may not end up using all of the funds, but the funds are there in case they do.
When do you need a loan agreement?
There are many situations where a loan agreement may be appropriate, such as:
- Starting a business, entering into a joint venture, or financing the purchase of an existing business
- Borrowing money to reduce financial pressures
- Purchasing assets
- Purchasing your own home
What should a loan agreement include?
A well-prepared loan agreement in its simplest form can be viewed as your insurance policy for the future. It is important that there be a loan agreement in place when someone defaults. When drawing up a loan agreement, make sure it includes:
- the parties involved
- borrower guarantors (if appropriate)
- key dates and timeframes for the enforcement of the agreement, as well as when the credit is to be transferred and when it will be paid
- the amount of money the borrower requires and the reason why they need the money, and any restrictions on how and when they may use any money
- how repayments will be made (e.g. in a single lump sum or via monthly installments)
- interest rates and how they will be calculated
- what security or guarantee is required
- appropriate charging clauses
- information required to ensure the borrower remains solvent and how often it should be sent to the lender
- detailed provisions surrounding borrower defaults and/or inability to repay the loan
- solicitor certificates explaining the nature of the loan when appropriate
Frequently Asked Questions
We recommend executing the agreement in front of an independent witness (not a party to the agreement) if you are entering into the agreement as an individual. The witness must be over the age of 18, of sound mind, and not under the influence of drugs or alcohol.
Having the agreement executed in front of and signed by a witness might assist with mitigating future arguments with respect to the identity of the person signing the loan agreement. Remember, the loan agreement is intended to protect a party's interests in the event that a dispute arises.
Under the Corporations Act (in particular section 127), a company may execute the agreement without the need of a witness, so long as they comply with section 127 of the Act, which requires either the agreement be signed by:
- two (2) directors of the company; or
- a director and a secretary of the company; or
- the sole director/secretary of the company.
A lender may still require you to have a witness, but effectively, a lender can assume that the company has signed the document if the above is complied with.
Yes, it's a legally binding contract between two or more parties to formalise the process of lending money and paying it back.
From a lawyer's perspective, a handshake deal on anything is never recommended. The same applies when lending or borrowing money. A loan agreement records the intention of the parties and the rights of each party. It is a physical piece of evidence when disputes arise and can quickly be reviewed to establish how the parties are to conduct themselves in an event of a dispute. Believe us when we say that disputes happen more often than you would expect!
How TNS Lawyers Can Help
Whether you’re entering into a short-term loan agreement or a more complex borrowing arrangement, our lawyers can explain the risks and benefits of the agreement you’re entering into and help you protect your interests throughout the loan period.
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