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Most people will encounter loan contracts (or loan agreements) at some point in their lives. A loan contract is an agreement between a borrower and a lender, such as a bank. The loan contract governs the terms of your loan. Additionally, it will outline your rights and obligations as a borrower. A loan contract is legally enforceable. This means that the lender can go to court if you do not uphold your responsibilities under the contract. Therefore, a loan contract needs to contain terms that protect both the borrower and lender in case of a dispute. This article will explain what key terms you should consider including in a loan contract.

1. Length of the Loan

The loan contract needs to contain how long the loan will be for. If you are getting a mortgage, it is common to have a 30-year loan. This means that you must pay off the principal of your loan within 30 years. This term can change if you and your lender both agree to use a different time frame.

2. Interest Rate

Interest payments are essentially the costs of your loan. It is charged as a percentage of your principal and is usually on a per annum basis. There are two ways to calculate interest. These are:

  • fixed interest rate; or
  • floating interest rate.

A fixed interest rate does not change and can be whatever both parties agree to at the start of their loan term. Importantly, loans with a fixed interest rate will generally become floating after a certain number of years. Banks often use this strategy to encourage people to borrow from them.

On the other hand, a floating interest rate will vary depending on the market interest rate. For instance, if the Reserve Bank of New Zealand increases the Official Cash Rate, interest rates will generally go up. This means that it will become more expensive to borrow money. Therefore, it is generally best to go on a floating interest rate if you believe that interest rates will decrease in the future. 

3. Security

When you borrow money from a financial institution, you will need to provide some sort of security over the mortgage. 

Security is something of value that the financial institution can take and sell if you cannot pay back your loan. For example, if you take out a mortgage, the security will usually be the house that you buy.

Whatever you use as security should be clearly defined on your loan contract. By doing this, the financial institution knows what they can take in the event you do not uphold your obligations under the contract.

4. Purpose of the Loan

The purpose of the loan should also be clearly stated in your loan contract. Indeed, if you are borrowing money for a specific purpose, using the money for something else might be considered a breach of the loan contract.

5. Payment Schedule

You also need to consider what your payment schedule will be. Specifically, you should consider whether the instalments by which you pay back your loan are:

  • weekly;
  • monthly; or
  • yearly instalments. 

The payment schedule should also state whether your loan is interest-only for a certain number of years. An interest-only loan means that you are only obliged to pay the interest on your loan for a certain number of years. After this time has elapsed, you will have to pay both the interest and the principal.

6. Guarantee 

If you do not have enough income or sufficient security, you may need to consider having a guarantor. A guarantor is someone with enough income and security to guarantee your loan. Essentially, this means that they have the responsibility of paying back your loan if you cannot meet payment obligations.

7. Default Proceedings

Finally, your loan contract should contain a section that refers to default proceedings. Default proceedings is the process initiated if you are unable to pay back your loan and must default. This section will clearly state the process and the financial institution’s rights when it comes to your default. Additionally, this section will usually set out the default fees that apply.

Key Takeaways

When you are looking to borrow money, you will likely enter into a loan contract. While you will usually borrow money from a bank, you can also borrow money from a finance company or an individual. The loan contract ensures that your rights are protected, and a dispute resolution process exists. It is important that you draft your loan contract correctly so that it is enforceable in court. For legal assistance with loan contracts, contact LegalVision’s corporate lawyers on 0800 005 570 or fill out the form on this page.

Frequently Asked Questions

Do I have to use a guarantor for my loan?

No, you do not need to have a guarantor if you have sufficient income or have enough security for your loan.

Can the purpose of the loan change?

Yes, the purpose of the loan can change if the loan’s involved parties agree to it. However, if one party changes the purpose without the other’s permission, they could be in breach of contract.

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