Incredibly, thousands of loans are made each day to borrowers who don’t know anything about their deal except that payments are due and the collateral will be sold if they aren’t. There is so much more the borrower should know.
Loan agreements are full of fine print which provide for many potential situations which may befall the borrower. Naturally these terms are designed to protect lender at the borrower’s unlimited expense.
Knowing about these terms does not mean that any of them will be changed or negotiated away, but the loan terms hidden in the fine print can be quite devastating if things don’t work out right. Knowing the consequences of your actions or the risks you take can sometimes make decisions easier to decide.
Some common loan agreement terms of which to be aware:
- Late Fees – Most loan agreements provide for a late fee if payments are not made within five days of the due date. These late fees can be as much as 5% of the payment amount, so if your $2,000,000 loan requires a $25,000 monthly payment, that could be $1,250!
- Default Rate of Interest – Many loan agreements provide for a “default rate” of interest. The default rate means that if the loan is declared by the lender to be “in default,” the interest rate will increase to a higher rate specified in the note. Higher rates mean either that your payment will increase or your loan will not be paid off as originally scheduled.
- Attorney’s Fees – Most loan agreements provided for the borrower to reimburse the lender for any attorney’s fees they incur while trying to collect your payments or convert your collateral. Depending on state law, those legal fees can be as much as 15% of your loan balance!
- Jurisdiction – Many loan agreements will define the jurisdiction of a particular Superior or State court where any question about the loan is to be heard. Whether or not this provision can be enforced may depend on the state in which you reside. But if applicable, it may significantly increase your litigation costs if you don’t live in that jurisdiction.
- Arbitration – Some loan agreements might provide for conflict resolution to be restricted to arbitration, and specify the arbitrators. This method may be advantageous or may limit some of your access to challenge certain acts of the lender or their interpretation of the terms.
- Endorsement – Some loan documents cleverly build in a personal guaranty by having the signer ““endorse” the note. Whether or not this condition was negotiated, discussed, or agreed to, your signature may obligate you personally.
- Acceleration – Most loan agreements provide for an accelerated maturity in the event of the default. That means if you are declared in default, the entire sum of the loan can be called declared due and payable.
- Events of Default – Most loan agreements will define a list of events or conditions that the lender reserves to be declared as an “event of default.” These items may include late or unpaid loan payments, unpaid insurance, unpaid property taxes, a declaration of bankruptcy or insolvency, or any number of other legal or financial conditions which the lender may reserve the right to call the loan.
- Dragnet Clauses – A lender may include “dragnet” clause when defining collateral, which will ostensibly place the lender’s lien on whatever assets specified, whether they have perfected their lien or not. This clause gives them standing to seek the liquidation or proceeds from liquidation of many more assets than the lender actually financed.
- Insurance – Most loan agreements provide for a requirement of the borrower to maintain insurance coverage for the collateral assets during the life of the loan. If that coverage lapses, the lender has the right to “force coverage,” which is to say that the lender buys a policy and you have to pay for it. Forced coverages are always very expensive, since the lender is not sensitive to the costs and the insurer is providing coverage through a third party.
Merely being aware of these terms does not change them, but may make you a little more responsive to the payment dates. Sometimes these provisions are never invoked, though the borrower abuses their responsibilities under the transactions. But be aware that the lender has many rights that can be very costly to the borrower if used.
Recognize that the “due” dates for payments are intended to define when they are expected. Collateral is intended to protect the lender from loss, and if its sale falls short of redeeming the debt, the lender can pursue other expensive options to recover their money.
Know these terms before you sign the loan agreement.