Loan agreements will vary from bank to bank. But no matter if you are considering a loan from a commercial bank, a credit union, or another financial institution, it's important to know how to read loan agreements. Follow this guide on how to read all of the documentation included in loan agreements from banks.
Understand the definitions on the loan agreement. Although you're probably compelled to skip the mundane definitions page, it is important that you understand the definitions of the terminology used in loan agreements from banks. Take time to review each term and ensure that you have a proper understanding of the wording used before reading the loan agreement. Here are a few key definitions.
- Representations and warranties: Representations is just the legal word for your promise to the bank that you complied with the conditions before you received any financing. A warranty refers to the promise you are making as a borrower during the term of the loan.
- Due authorization: This is another legal term that refers to your affirmation that you are the one authorized to bind your business to the terms of the loan from the bank. (You'll probably need to sign an affidavit to confirm this.)
Understand all elements of the promissory note. As you read through the loan agreements from banks, you will come across the promissory note. This is the ‘meat' of the loan agreement. It outlines all the specific details of the loan, including how it will be repaid, the rate of interest and the initial principal amount. It will also mention the length of the loan and any fees you will incur as a result of late payment or prepayment. Here is common terminology used on promissory notes:
- Default: When you default on a loan, you fail to make payments on time or you don't meet the conditions of the loan. If you default, you may be asked to repay the entire loan immediately and this will negatively affect your credit. (A good loan agreement or promissory note allows you a grace period of one or two weeks to make amends with the bank before your account is sent to a collections agency, so look through your loan documents from banks and understand this policy.)
If you want to secure your loan with collateral, understand the security interest documentation. Many small business owners will put up personal equity or capital to secure a loan from a bank. If you agree to this, you will also be required to sign security interest documentation. It will lay out any interest a bank or lender would have in whatever capital you are using to secure your loan. It's basically assurance that you're not going to default against your loan. (Otherwise, your capital goes to the bank and you lose ownership). Here is a definition related to security interest documentation.
- Lien: A lien is basically a hold put on a piece of property by a lender. Although it belongs to you, you can't sell it until your loan has been paid off because of the lien on it. If you default on your loan, the bank or lender has the right to repossesses the property and claim full ownership, as detailed in the lien. (The document that creates a lien on your security interest is called a UCC-1).
Understand the guarantee and surety agreement. One final piece of documentation that is part of a loan agreement from a bank is the guarantee and surety agreement. This is yet another guarantee that the banks needs from you to ensure that you will not default on your loan. Once you sign the guarantee and surety agreement, you are giving the bank permission to go after your personal equity (home, car, savings, and investments) to pay off your loan. This may be the case for both private businesses and corporations. Ensure that you understand the terms of your loan agreements from banks so that you are not a victim of the fine print.