What Is a Business Loan Agreement?
A business loan agreement is a document that holds all of the logistical details of business debt that a borrower is about to take on. Reviewing your business loan agreement before signing the dotted line is an absolute must. Otherwise, you’re taking on a business loan with terms that you aren’t even aware of.
In an ideal situation, you’d have a lawyer to help you go through the agreement, but if not, don’t worry. You will just have to be that much more careful about making sure you’re aware of what’s in the business loan agreement that you’re about to sign. While we certainly can’t replace a lawyer, and cannot give legal advice, we can help you be as educated as possible when it comes to understanding your loan agreement.
Business loan agreements hold crucial logistics, so here are 12 details you should check before signing:
- Loan amount
- Term length
- Total loan cost
- Prepayment penalties
- Penalty fees
- Definition of default
- Type of interest rate
- Late payment fees
- Payment schedule
- Terms to know
- Check for red flags
This is far from an exhaustive guide, and every business loan agreement will have different features to look out for, but these are some of the most important things to look out for. We’ll go into each one in more detail below.
What Does a Business Loan Agreement Include?
If this is your first time taking out a business loan, you might not know what to look for when it comes to the terms of your loan and the basics that it should include. There are a few things you should look for in your business loan agreement that you need to confirm before doing anything else.
1. Loan Amount
For starters, you’re going to need to confirm that you’re signing on to borrow the business loan amount that you think you’re signing on to borrow. Although it’s unlikely that your business loan agreement will have a different loan amount than previously discussed, this should be your first point of reference when reviewing it.
Once you’ve checked out the loan amount the next thing for you to do is check on the loan’s APR. The loan’s APR will measure how much it will cost you every year that you’ll be repaying it, interest and fees included.
Your loan’s APR should be your point of reference for beginning to grasp how much your business loan will end up costing you. It’s actually a more accurate measure for determining your loan’s cost than the interest rate. Even a decimal of difference in your loan’s APR could end up changing your loan’s cost drastically. Sometimes a business loan agreement won’t explicitly state your APR. Instead, you could be quoted an interest rate or a factor rate, which you should then convert to APR to understand the true cost of capital.
3. Repayment Term
Now that you know your APR and the loan amount, check on the length of your loan’s repayment term. This will influence how much your loan will end up costing and how much your regular payments will be.
5. Prepayment Penalty
In addition to the basics we covered above, there’s more you’ll want to check out before signing a loan agreement. You should check if your loan comes with a prepayment penalty, which you would have to pay if you pay off your loan ahead of schedule.
Though it might feel like an arbitrary punishment for being financially responsible, a prepayment penalty compensates for the lost value that the lender might suffer due to your avoiding interest by paying off your loan early.
Not all loans come with prepayment penalties, but if they do, it’s crucial to know before you sign on.
6. Penalty Fees
“Penalty fees” is a blanket term that can change in meaning from one business loan agreement to another. Penalty fees come in different amounts and apply to anything a particular lender defines as a “penalty.” This could be any action that breaches the terms outlined in your business loan agreement, like a late payment.
7. Definitions of Default
This is one detail that you will definitely need to verify. Generally speaking, defaulting on a loan just means not paying it back as determined by the business loan agreement.
However, a lender can take this as literally or as loosely as they deem appropriate. For instance, not all business lenders will claim you’ve defaulted on your loan if you’ve missed one or two payments. On the other hand, some lenders will take a single missed payment very seriously.
If you “default” then your lender can technically pursue legal action against you and collect on what they’re owed. With so much potentially at stake, be sure to see how your lender defines default in your business loan agreement.
8. Type of Interest Rate
Whether it’s fixed interest or variable interest, your business loan agreement should delineate the details of what type of interest rate you’re agreeing to. Plus, if it’s variable interest, the business loan agreement should go into further detail about when exactly the rate will change.
9. Late Payment Fees
Next, you’re going to need to check on what late payment fees your lender will be charging you if you make a payment behind schedule.
Plus, you should see if your lender allows for any grace period for loan payments and if so, how long it is. These are all questions that your business loan agreement should answer concretely and definitively.
10. Payment Schedule
To make sure you never miss a payment, check on the payment schedule and be sure it’s what you agreed to when negotiating the loan in the first place. Whether your payments are daily, weekly, monthly, or otherwise will determine how quickly you pay off your loan and how expensive it will end up being. The schedule of your payments determines how much each payment will be.
To state the obvious, being certain about your payment schedule will allow you to avoid any late fees or penalties, as well.
Business Loan Agreements: Terms to Know
Most of the words and phrases in your business loan agreement will have incredibly specific meanings. While you might think you have a general idea of what the acronyms and phrases mean, it’s important that you have a firm grasp on all the loan terminology so that you know exactly what you’re getting yourself into.
Though this list won’t cover every single word you might come across in your business loan agreement’s fine print, it includes the definitions of many common loan terms that could potentially throw you off and even end up costing you.
Also known as Automatic Clearinghouse, ACH is a form of loan repayment that draws your loan payments, whether they be daily, weekly, or monthly, directly from your business’s bank account.
Loan amortization refers to the way in which loan repayments are structured. If your loan amortizes, you’ll repay your loan through equal, scheduled repayments that are most often on a monthly basis.
Though these payments will always be equal in value, they will include different parts of interest and principal repayment with each payment you make.
What does that mean, exactly? It just means that as you continue to pay your monthly loan payments, they’ll be the same amount, but that amount will be paying back interest less and less and paying back the principal debt more and more.
Annual percentage rate, most often referred to as APR, is a way to indicate how expensive borrowing money will be. APR is denoted in a percentage that indicates how much a loan will actually cost you every year for the term of the loan.
A balloon payment is when you pay off the principal debt that you owe in one huge lump sum at the end of the life of the loan. Throughout the life of the loan, if you have a balloon payment, your regular payments will only cover the cost of the loan’s interest.
A blanket lien gives the lender a right to all of the borrower’s assets if the borrower defaults on a loan. Essentially, a blanket lien means that if you default on your loan, your lender could seize your property until the value of the loan is made up for.
If you have a co-signer for a loan, your co-signer will have to pay off the loan if you aren’t able to. Think carefully before you ask someone to co-sign or you agree to co-sign.
Curtailment essentially means paying more for your loan than your pre-planned loan payment. If you perform a partial curtailment, you’re able to pay more toward your loan than you expected, but you don’t pay your loan off in full. A full curtailment, on the other hand, means you pay off your loan in full.
To default on a loan means you don’t pay the loan back according to the loan’s agreement. If you default on a loan that you legally agreed to, the lender can take legal action against you and your business or if you have a co-signer, they could also be on the hook.
Deferred Payment Loan
A deferred payment loan is when the borrower and the lender arrange an agreement that allows the borrower to begin payments at a specific time in the future rather than immediately.
A factor rate is how a merchant cash advance or sometimes how a short-term loan is paid back. Typically expressed as decimals, factor rates will let you know how much you’ll need to repay in total. For instance, if your loan amount is $100,000 and your factor rate is 1.18, you’ll be repaying $118,000 in total.
Interest-Only Payment Loan
The interest-only payment loan is an alternative to the traditional amortizing loan. Throughout the loan’s life, your regular payment will just be a decided-upon portion of the interest that your loan will acquire.
At the end of an interest-only loan, borrowers will either pay the principal sum off in full or refinance it with another loan.
Standing for Loan-to-Value Ratio, a loan’s LTV ratio denotes how much of the value of an asset a loan will cover. This will be particularly pertinent to business owners securing equipment financing or commercial real estate loans because they will need to know how much of what they want to buy with the loan will be covered by the loan.
Loan underwriting essentially means the process that a lender goes through to assess how much of a risk a particular borrower is. The underwriting process will determine both if you qualify for the loan and under what loan terms you qualify for.
This is an important phrase to look out for in your business loan agreement—if your business loan has a prepayment penalty, you’ll still have to pay interest, even if you pay the loan off early.
Essentially, when you schedule your payments for a loan, you’re promising the lender a specific amount of value in interest that they’ll earn. If you pay your loan back early, the lender will get cut off from the interest that you would have left to pay. That’s why many lenders attach prepayment penalties to their business loan agreements.
Principal basically means the amount you borrowed, not including interest. If you borrowed $100,000 for your business, then your principal is $100,000.
Refinancing debt is the act of paying off one loan with another one. Borrowers can refinance loans with other loans that offer better terms.
Business Loan Agreement Red Flags
If in going through your loan agreement, you’re having some second thoughts about the lender, that’s an important feeling to consider. Red flags can be spotted in even the smallest of details, especially when it comes to business loans.
Before you sign that business loan agreement, let’s go over some worst-case-scenario warning signs that you might be about to sign on to a questionable loan:
Requesting Money Upfront
If your lender is requesting you to pay money upfront, this could be a sign of an untrustworthy lender. Even if they cite a specific purpose for the payment—be it a credit check, an application fee, or a brokering fee—a request for a one-off, upfront payment is a sign of shady practices.
Guaranteeing Your Approval
If your lender guaranteed you a loan before even seeing your business’s credentials, you could be dealing with a questionable lender. If your direct point of contact with this lender was a guaranteed offer, then you might be on the verge of signing onto a loan scam.
High-Pressure Sales Tactics
Did you feel pressured into pursuing this loan? You might have gotten this far in the process simply because you felt like you couldn’t say no. Take a moment or two to consider whether you’re really ready to take on debt with the terms laid out by the business loan agreement. If not, simply don’t sign.
Terms Too Good to Be True
Lastly, if you’re signing a business loan agreement that delineates terms that are just too good to be true, then, unfortunately, they probably are.
Be sure to compare the business loan agreement terms to other offers to see if any are comparable. If the terms of the business loan agreement that you’re about to sign are in a league of their own, then you should probably double down on verifying the credibility of your lender before signing.
Frequently Asked Questions
The Bottom Line
With all of those steps covered, hopefully, you’re feeling good about the business loan agreement in front of you.
Remember to always consult an expert when making big financial decisions like this, but if you’re eager to take the first steps on your own, this guide can help you do it.