How to Find an Apartment Loan

Buying an apartment building isn’t the same as purchasing smaller investment properties. The payoff can be higher but the risk may be higher.

A multifamily apartment building can have excellent income potential. It might generate consistent cash flow and grow your real estate portfolio. Plus, when you have a vacancy (or even a few vacancies), they likely won’t impact your bottom line like a vacancy in a single-family rental property would.

On the other hand, apartment complexes aren’t very liquid. They can take time to resell if the need arises. As a result, lenders often consider apartment loans as higher risk.

Due to the increased risk, qualifying for apartment building loans can be a financial challenge. You’ll generally need a lot of money upfront in the form of a large down payment and significant reserves. Lending standards, however, may be easier to satisfy. Commercial lenders care more about the value of the property than your personal credit qualifications.

5 Types of Apartment Loans

Despite the risk, there are multiple ways to finance the purchase of an apartment building. You’ll probably have several options to choose from when you start searching for commercial loans for a multi-family apartment complex.

Having multiple loan options is good. It means you don’t have to settle for the first offer you find. Instead, you can take your time to look for the best offer available for your situation.

Below are five common types of multifamily apartment loans. We’ve broken down the highlights of each to help you compare your options.

Fannie Mae Apartment Loans

Fannie Mae’s Multifamily platform has numerous loan programs that might help you in your search for affordable apartment loans. You can borrow as little as $750,000 with loan terms potentially as long as 30 years.

Fannie Mae’s multifamily financing options include:

Conventional Loans

Specialty Loans (Affordable Loans, Green Financing, Seniors Housing, etc.)

You’ll typically need a down payment of 20% or larger to borrow. Because the federal government backs the loans, they represent less risk for lenders. Therefore interest rates tend to be competitive when compared with other financing options. Still, you should always shop around for the best rate and terms to be sure.

Freddie Mac Apartment Loans

Through its Optigo program, Freddie Mac provides several options to consider when you need multifamily housing loans. Whether you want to borrow $1 million or $100 million to purchase a real estate investment, Freddie Mac might have a solution that can help.

Freddie Mac’s multifamily Optigo loan offerings include:

Conventional Loans

Small Balance Loans

Targeted Affordable Housing

Seniors Housing

If you qualify for an Optigo loan for a purchase or refinance, you can generally expect competitive interest rates compared with other apartment building financing options. The federal government backs these loans as well — reducing the lender’s risk.

Your repayment terms on some of the program’s fixed-rate loan options could potentially extend as long as 30 years. In general, you’ll need a sizeable down payment (20% or more) to qualify for funding.

Bank Balance Sheet Apartment Loans

Bank balance sheet apartment loans are another type of commercial financing you can use to purchase an apartment building. However, banks don’t package up and sell these loans to a government-sponsored enterprise (GSE) like Fannie Mae or Freddie Mac after closing. Rather, the loans are kept in house and sit on the bank’s balance sheet.

Balance sheet loans are available from many traditional banks, but online lenders and life insurance companies may offer them as well. The loans are often full recourse loans, which means you can be held personally liable for the debt if something goes wrong. In other words, the lender may be able to seize your personal assets to try to recuperate its losses.

Your personal credit score may also be reviewed as part of the application process. So, a better credit rating might help you land a better deal on financing. Need to review your credit? Nav’s platform gives you access to your personal and business credit information in one spot.

Expect to pay at least 20% down for a bank balance sheet apartment loan. However, you might need to provide a more significant down payment depending on the lender’s requirements.

FHA Apartment Loans — Existing Properties

If you’re looking to purchase or refinance an existing apartment building with five or more units, an FHA Multifamily loan could help. FHA 223(f) loans are insured by the U.S. Department of Housing and Urban Development (HUD). HUD lenders package and sell the loans on the secondary mortgage market after closing, allowing for better interest rates and terms for borrowers.

Interest rates can be competitive on FHA apartment loans, but you should weigh other costs and factors too. For example, the funding process has a reputation for being slow and tedious with strict qualification standards.

Repayment terms on FHA apartment loans may extend as long as 35 years. The loans are non-recourse, so your risk is lower in the event of a default. However, mortgage insurance is typically required on these loans, so be sure to factor that into your cost comparisons.

The minimum loan amount for an FHA apartment loan starts at $3 million. For new purchases, a lender may be willing to finance up to 83.3% of the purchase price. This could result in a smaller down payment amount for you, the borrower.

Apartment Construction Loans

Do you want to rehabilitate an apartment building or build a new one from scratch? If so, you’ll need to consider apartment construction loan options instead of traditional multifamily commercial financing.

Conventional Construction Loans, backed by Fannie Mae or Freddie Mac, may have a program to help you secure the financing you need. For example, the Rural Development Guaranteed Rural Rental Housing Program from Fannie Mae can fund the construction or rehabilitation of eligible multifamily properties. Freddie Mac also offers a Moderate Rehab Loan that can fund rental property renovations.

Rates, terms, and fees vary from program to program. So, your best bet is to contact a Fannie Mae or

Freddie Mac lending partner to review your borrowing options.

The FHA 221(d)(4) loan, guaranteed by HUD, can help you finance the construction of a new multifamily apartment building. Minimum loan amounts generally start at $4 million, but most loans are $10 million and up. Financing terms can extend as long as 40 years. You may also be able to take advantage of interest-only financing during the construction period.

Balance Sheet Loans can also be used to finance the construction or rehabilitation of an apartment complex. Because lenders hold the loans in house, they don’t have to comply with Fannie Mae, Freddie Mac, or FHA guidelines. You can check with individual lenders to learn more about loan rates, terms, and qualification criteria.

Apartment Loan Calculator (How to Calculate Interest)

Finding the right type of financing should be high on your list of priorities when you’re buying an apartment building. When you find the right apartment loan, it could help you to save money and make your investment more profitable overall.

Of course, it can be difficult to tell on the surface which loan is most affordable. Even comparing the interest rate on multiple loans won’t tell you the whole story.

The best way to shop for an apartment loan is to compare all of the terms and costs of multiple financing solutions side by side. You can start by calculating the cost of financing, including interest rates and fees.

Alternative Apartment Financing Options

If none of the traditional multifamily apartment loans above work for your situation, you may still be in luck. An alternative apartment financing option could be a better fit.

Commercial Mortgage Backed Securities (CMBS)

A CMBS loan, also called a conduit loan, is a non-recourse commercial real estate loan you can use to purchase an apartment complex. The asset-based loans are secured by the property you’re buying. After closing, CMBS loans are packaged and sold on the secondary mortgage market, similar to government-backed loans.

The minimum loan amount for a CMBS is usually $2 million. But the average maximum LTV is 75%, meaning you may need to put down 25% or more to secure funding. You may also need to show significant cash reserves to qualify.

Although the loans may feature a 30-year amortization period, you’ll generally receive a shorter repayment term of 5–10 years. CMBS loans may have a sizable prepayment penalty attached, so be sure to carefully review fees and terms before you commit to this type of financing.

Hard Money Loans

Hard money loans, sometimes called bridge loans, are an alternative form of financing commonly used by real estate investors. Bridge loans are short-term funding solutions and must often be repaid or refinanced in 36 months or less.

If you’re searching for a hard money loan, you probably won’t find one at your local bank. Instead, hard money lenders are typically private companies or individuals.

Hard money loans may fund much faster than traditional property loans. You might receive funding in just a few days if you qualify. However, this convenience comes at a cost. Interest rates and fees on hard money loans may range from 8% to 15%. You may also be required to come up with a 20% to 30% down payment.

If you’re considering a hard money loan, make sure you understand the risks and costs clearly upfront. Pay special attention to origination fees, repayment terms, prepayment penalties, and any balloon payment requirements. (Note: If your loan features a balloon payment, you’ll have to pay off the remaining balance or refinance your investment property by that date.) It’s also wise to research a hard money lender’s reputation online before you apply for funding.

Business Loans

Traditional business loans, such as those offered by the Small Business Administration, usually aren’t the right choice for an apartment loan purchase. Yet there’s a chance you might find a business lender that’s willing to help you finance your investment property.

You can visit the Nav Marketplace to compare available business loan offers. It’s also a good idea to review both your business and personal credit reports and scores before you apply for any new business loan.

Commercial Construction Loans: The Ultimate Guide

You’ve reached the point in your business when it’s time to expand. Maybe you’re renting your office space and you’ve decided that it’s time to build your own office building.

Perhaps you’ve outgrown your property and you want to add on to your existing space. Your scenario could be completely different: you’re a new business just getting off the ground and you want to build your property from the ground up.

No matter what the circumstances, many businesses face a situation where real estate construction or improvements are the next steps for business expansion. Of course, this expansion comes at a very high cost – a cost that many businesses can’t afford to pay up front. This is when it’s time to consider taking out a commercial construction loan.

As with any other type of financing, it’s important to understand the mechanics behind a commercial construction loan.

Read on to learn more about commercial loans, when you should consider applying, and what to expect throughout the application process.

What Is A Commercial Construction Loan?

A commercial construction loan is a type of loan that is used to finance the costs associated with the construction or renovation of a commercial building. The funds from a construction loan can be used to pay for labor and materials for the construction of a new property, the purchase and development of land for a new commercial property, or the renovations of existing properties.

Why Take Out A Commercial Construction Loan?

Business owners who plan to purchase existing commercial properties can get a loan known as a commercial mortgage. However, if you plan to renovate your existing space or construct a new building from the ground up, you’ll need to apply for a commercial construction loan.

New construction and renovations can be expensive — think hundreds of thousands or even millions of dollars. Most growing businesses don’t have this type of cash on hand, so instead, they turn to a commercial construction loan. With commercial construction loans, lenders provide funds throughout the construction process to pay for labor, materials, and land development so you don’t have to cover the costs yourself.

How Commercial Construction Loans Work

Commercial construction loans are different from other loans. Most loans are structured so that the borrower receives the full amount of the loan as one lump sum. Once the loan is received, the borrower begins to pay back the loan through scheduled payments over a set period of time. Commercial mortgages, for example, often have a monthly repayment schedule over 10 years or longer.

With commercial construction loans, the full amount of the loan is not received up front. Instead, the borrower will work with the lender to create a draw schedule. This means that partial amounts of the loan will be released as the project hits new milestones. For example, the first draw will be for the clearing and development of land. The next draw may then occur when the foundation is poured. Another draw will be released when the building has been framed, and so on.

As each milestone is completed, a lender will typically require an inspector to confirm that the work is completed before releasing the next draw. This will continue until all milestones have been completed and the full amount of the loan has been distributed.

With a commercial construction loan, you will only pay interest on the portion of the loan proceeds that have been received. If the total cost of your new construction is $500,000 but the lender has released just $100,000, you will pay interest on $100,000.

Typically, a commercial construction loan is structured so that the borrower pays only the interest until the loan has been fully disbursed. Borrowers can then pay off the principle in one lump sum at the end of the construction project.

But once the project is done and the full amount of the loan is due, what does a borrower do next? Instead of having to make one large payment, the borrower now can receive a commercial mortgage. The property will serve as collateral, and the borrower will use the funds from the commercial mortgage to pay back the commercial construction loan. With the new mortgage, the lender will now be locked into more affordable monthly payments over a longer period of time.

Other commercial construction loans like the Small Business Administration CDC/504 loan provides more long-term options so an additional loan following the completion of the project will not be needed.

Interest Rates

For commercial construction loans, borrowers should expect to pay interest rates between 4% and 12%. Borrowers with the best credit scores will receive the lowest interest rates. The type of lender you work with is also a factor. A commercial construction loan from a bank will typically have the lowest interest rate, while hard money lenders charge more interest for their loans.

Fees

There are several fees that may be associated with taking out a commercial construction loan. The fee types and amounts vary by lender. Some fees you may have to pay for this type of loan include:

Guarantee Fees

Processing Fees

Documentation Fees

Project review Fees

Fund control Fees

Down Payment

Because a commercial construction loan is a high-risk loan, a down payment is required. By paying a down payment, the borrower takes some of the risk off of the lender. Typically, down payment requirements are 10% to 30% of the total project cost. Rarely will a lender fund 100% of the costs of a commercial construction project.

Conventional lenders use a calculation known as loan-to-cost for commercial construction loans. The loan-to-cost ratio is calculated by dividing the total amount of the loan requested by the total project cost. Let’s say, for example, a business is requesting a loan of $190,000 for a project with a total cost of $200,000. The loan-to-cost in this example would be 95%.

Though requirements vary by lender, most require a loan-to-cost of 80% to 85%. For the example above, the lender would loan $160,000 at 80% and $170,000 at 85%.

If this occurs, what does the borrower do? While they may be forced to come up with the remaining costs out-of-pocket, there is another option — mezzanine loans — which we’ll discuss a little later.

Borrower Requirements: How Commercial Lenders Evaluate Eligibility

Not all construction projects are eligible for a commercial construction loan. There are several factors that a lender will consider in order to determine eligibility.

One of the first things that a lender will look at is your credit score. Because these are high-risk loans, lenders want to work with low-risk borrowers with high credit scores. Though credit requirements vary by lender, you should have a credit score at least in the high 600s before applying to qualify for loans such as the SBA CDC/504 loan. Other lenders may require a minimum score in the 700s. Business credit scores will also be evaluated.

The lender will also consider your debt-to-income ratio, also known as DTI. This ratio shows the relationship between the income and the debt of your business on a monthly basis. Typically, lenders look for a debt to income ratio of 43% or less, although some lenders may have stricter requirements. The lower your DTI, the higher your chances for approval. To calculate your DTI, use the following formula:

Total Monthly Debt Payments / Gross Monthly Income = DTI

Lenders will also consider your debt service coverage ratio, or DSCR. This shows the relationship between the income and debt of your business on an annual basis. To calculate for yourself, use the following formula:

Net Operating Income / Current Annual Debt Obligations = DSCR

The DSCR is a bit different from DTI because you want this number to be higher. This shows that your business is bringing in enough income to cover new debts. Most lenders look for a DSCR of 1.25 or higher, but again, requirements vary by lender. Learn more about calculating your DSCR.

The lender will also look at your industry experience and your current business financials to determine if you qualify for a loan. You’ll need to submit detailed construction plans for approval before a loan can be issued. In some cases, the plans may need to be altered based on any risks spotted by the lender, so your ability to be flexible in your plans is key.

Types Of Commercial Construction Loans

Now that you know more about the commercial construction loan process, it’s time to explore the different types of loans available.

SBA CDC/504 Loan Program

The Small Business Administration (SBA) CDC/504 loan is one of the most popular commercial construction loans. This is because these loans come with low down payments, competitive interest rates, and credit score requirements in the high 600s.

Borrowing Amount

No maximum, but the SBA will only fund up to $5 million

Term Lengths

10 or 20 years

Interest Rates

Fixed rate based on US Treasury rates

Borrowing Fees

CDC servicing fee, CSA fee, guarantee fee, third party fees (however, most of these fees are rolled into the interest rate or cost of the loan)

Possible prepayment penalty

Personal Guarantee

Guarantee required from anybody who owns at least 20% of the business

Collateral

Collateral required; usually the real estate/equipment financed

Down Payment

10% – 30%

With this loan, an SBA-approved Certified Development Company will fund 40% of the costs to renovate existing facilities, build new facilities, or purchase/improve land. Up to $5 million is available for borrowers.

Another lender will need to provide 50% of the project costs, while the borrower will be responsible for the remaining 10%. In some cases, borrowers may be required to pay 20%. Repayment terms are available up to 20 years, and interest rates are based on the market rates of U.S. Treasury issues.

SBA 7(a) Loan Program

The SBA also has the 7(a) program, which can be used for the purchase or construction of commercial real estate.

Through this program, borrowers can receive up to $5 million with repayment terms up to 25 years. Interest rates are based on the prime rate plus a maximum of 2.75%. To qualify, borrowers should have a credit score in the high 600s and a down payment of 10% to 20%.

Here are the base rates and markups for a 7(a) loan from the SBA:

Loan Amount      Less Than Seven Years    More Than 7 Years

Up to $25,000

Base rate + 4.25%

Base rate + 4.75%

$25,000-$50,000

Base rate + 3.25%

Base rate + 3.75%

$50,000 or More

Base rate + 2.25%

Base rate + 2.75%

Bank Loans

A traditional commercial construction loan from a bank is another option for business owners. Rates, repayment terms, and down payment requirements vary. Generally, a minimum down payment of 10% is required, maximum repayment terms of 25 years are standard, and fixed and variable rates are available.

You can start your lender search by talking to your current financial institution about your financing needs. See our post on the best bank loans for small business if you’re interested in specific recommendations.

Mezzanine Loans

Earlier in this post, we discussed loan-to-cost ratios. When a loan-to-cost ratio is lower and the borrower needs to come up with additional money, a mezzanine loan may be an option. This type of loan is secured with stock. If the borrower defaults, the lender can convert to an equity stake. With a mezzanine loan, the borrower has more leverage and can achieve a loan-to-cost ratio of up to 95%.

Where To Find Commercial Construction Loans

You know about the types of loans available to you, so where do you find a lender? This all depends on the type of loan you’re seeking.

An SBA-approved intermediary lender (which includes banks, credit unions, and private lenders) distributes 7(a) loans. For CDC/504 loans, an SBA-approved non-profit CDC provides this funding, although you’ll also have to find another lender to finance 50% of your project costs.

Banks and credit unions provide many commercial construction loan options, including SBA loans, traditional loans, and mezzanine loans.

Finally, commercial construction loans can be obtained through hard money lenders. These are private money lenders that provide short-term funding options for commercial construction projects. While there are a few benefits to working with these lenders, including minimal upfront costs and faster funding, these loans typically come with higher interest rates and fees than options from other lenders.

How To Apply For A Commercial Construction Loan

Once you’ve found a lender for your commercial construction loan, the next step is to begin the application process. During this process, the lender will evaluate your personal and business financials, your credit score, and other factors that will determine both whether you’re approved and what your interest rates and terms will be.

Because construction loans are considered high-risk, you will need to provide the lender with a detailed business plan. This should include an overview of what your business does, its financials to date, details about your current operations, and future projections.

You will also need to provide your lender with details about the project. This includes a complete plan with specs and designs. An expected project cost, including estimates for contractors, materials, and other expenses, must be provided with your application.

Personal and business financial documents will also need to be submitted during the application process. These include, but are not limited to, personal and business tax returns, profit and loss statements, balance sheets, bank statements, income statements, and debt schedules showing current debt obligations. Documentation requirements will vary by lender.

The lender will pull your credit score during the process. Remember, lenders are looking for scores in the high 600s. With some lenders, negative items such as bankruptcies, foreclosures, and past defaults on loans may automatically disqualify you from receiving a loan. For negative items on your credit report, an explanation to the lender may be required.

Because this is such a high-risk loan product, lenders will typically take at least a minimum of several weeks to go over your information. During this time, more documentation may be required or your lender may have questions, so make sure to make yourself available to expedite the process.

Once the lender underwrites and approves your loan, you’ll move into the closing process. This entails going over the loan agreement, which will include all dates and milestones throughout the process. Once all paperwork has been signed and the closing process is complete, you’ll be ready to begin the expansion of your business.

Final Thoughts

It’s always exciting to reach a point in your business when it’s time to expand, but getting the financing you need can be a challenge. If your future plans include constructing new facilities or upgrading your current building, getting a commercial construction loan doesn’t have to be stressful.

If you understand the types of loans and requirements and do some prep work ahead of time, you’ll be able to approach your lender with confidence and get through the lending process with ease.

How Commercial Construction Loans Work and How to Get A Loan

Commercial Construction Loans

Securing a commercial construction loan for various types of commercial real estate can be a difficult process to navigate. This post will shed some light on commercial construction loans and demystify the lending process.

Commercial Construction Loans and Lenders

The construction loan process begins when a developer submits a loan request with a lender. Construction or development lenders are almost always local community and regional banks.

Historically this was due to bank regulation that restricted trade areas for lending. More recently, life insurance companies, national banks, and other specialty finance companies have also started making construction loans.

However, community and regional banks still provide the majority of construction financing, since they have a much better understanding of local market conditions and the reputation of real estate developers than larger out of area banks.

There are two normally two loans required to finance a real estate development project, although sometimes these two loans will also be combined into one:

  • Short term financing. This stage of financing funds the construction and lease up phase of the project.
  • Long term permanent financing. After a project achieves “stabilization” and leases up to the market level of occupancy, the construction loan is “taken out” by longer term financing.

When a bank combines these two loans into one it’s usually in the form of a construction and mini-perm loan. The mini-perm is financing that takes out the construction loan, but is shorter in duration than traditional permanent financing.

The purpose of the mini-perm is to pay off the construction loan and provide the project with an operating history prior to refinancing in the perm market.

Commercial Construction Loan Underwriting

After the initial loan request is submitted, the bank typically goes through a quick internal go/no-go decision process.

If the project is given the go-ahead by the bank’s senior lender, the lender will sometimes issue a term sheet which outlines the terms and conditions of the proposed loan, provided all of the information presented is accurate and reasonable.

Once the non-binding term sheet has been reviewed, negotiated, and accepted, the lender will move forward with a full underwriting and approval of the proposed loan.

Underwriting

During the underwriting process the lender will evaluate the proposed project’s proforma, the details of the construction budget, the local market conditions, the development team and financial capacity of the guarantors, and in general address any other risks inherent in the loan request.

Typical documents required in the underwriting process include borrower/guarantor tax returns, financial statements, a schedule of real estate owned and contingent liabilities for the guarantor(s), the proposed project’s proforma, construction loan sources and uses, cost estimates, full project plans, engineering specifications, and in general, any other documents that can support the loan request.

From an underwriting standpoint, one of the most notable differences between a commercial construction loan and an investment real estate loan is that with a construction loan there is no operating history to underwrite.

The economics of the project, and thus the valuation of the property, is based solely on the real estate proforma.  The credit approval process is similar to other commercial loans, but because of the additional risks inherent in construction loans, further consideration is given to the development team and general contractor, as well as the prevailing market conditions.

Loan Approval

Once the commercial construction loan is approved, the bank will issue a binding commitment letter to the borrower. The commitment letter is similar to the term sheet, but contains much more detail about the terms of the loan. Additionally, the commitment letter is a legally-binding contract whereas the term sheet is non-binding.

Commercial Construction Loan Closing and Beyond

Upon completion of the loan underwriting and approval, a loan then moves into the closing process, which can take on a life of its own. Commercial construction loan closings are complex and involve an overwhelming quantity of documentation and procedural nuances.

Typically, the closing is handled by the lender’s attorney, the borrower, and the borrower’s attorney.  A loan closing checklist is also normally issued to the developer along with the commitment letter, which outlines in detail what needs to be completed before the loan can close and funding can begin.

The Closed Loan

After a loan closes, the loan mechanics are primarily the responsibility of the loan administration department within a bank. The loan administer (sometimes just called the loan admin), will fund the loan according to the internal policies and procedures of the bank. Commercial construction loans are typically funded partially at closing to cover previously paid soft and hard costs. After the initial partial funding, loan proceeds are disbursed monthly based on draw requests for costs incurred. These costs are submitted by the developer and verified by the lender.

Commercial construction loans can quickly become complex and difficult to secure. But understanding how construction loans work and how commercial developments are evaluated by lenders can help demystify the funding process.

Loan Agreements: Everything You Need to Know

Winston Rowe & Associates

A loan agreement is a very complex document that can protect the two parties involved. In most cases the lender creates the loan agreement, which means the burden of including all of the terms for the agreement falls on the lending party.

Unless you have created loan agreements before, you will likely want to make sure that you completely understand all of the components so you do not leave out anything that can protect you during the lifetime of the loan.

This guide can help you create a solid loan agreement and understand more about the mechanics behind it.

Why You Need a Loan Agreement

Before you lend anyone any money or provide services without payment, it is important to know if you need to have a loan agreement in place to protect you.

You never really want to loan out any money, goods, or services without having a loan agreement in place to ensure that you will be repaid or that you can take legal action in order to have your money recouped.

The purpose of a loan agreement is to detail what is being loaned and when the borrower has to pay it back as well as how. The loan agreement has specific terms that detail exactly what is given and what is expected in return.

Once it has been executed, it is essentially a promise to pay from the lender to the borrower.

Borrowing money is a big commitment no matter the amount, which is why it is important to protect both parties with a loan agreement in place. A loan agreement not only details the terms of the loan, but it also serves as proof that the money, goods, or services were not a gift to the borrower.

That is important because it prevents someone from trying to get out of repayment by claiming this, but it can also help you ensure that it is not an issue with the IRS later.

Even if you think you may not need a loan agreement with a friend or family member, it is always a good idea to have this in place just to make sure there are no issues or disagreements over the terms later that could ruin a valuable relationship.

If you are trying to determine whether you need a loan agreement, it is always better to be on the safe side and have one drafted.

If it is a large sum of money that will be repaid to you, as agreed upon by both parties, then taking the extra steps to ensure that the repayment takes place is well worth your time.

A loan agreement is designed to protect you so when in doubt, create a loan agreement and make sure you are protected no matter what happens.

There are several components of a loan agreement that you will need to include in order to make it enforceable. These are a few of those components that are true no matter what type of loan agreement it is.

To help explain how a loan agreement is broken down, we have divided it into sections that are easier to comprehend.

The Basic Information Needed

With every loan agreement, you need to have some basic information that is used to identify the parties that are agreeing to the terms.

You will have a section that details who the borrower is and who the lender is. In the borrower’s section, you will need to include all of the borrower’s information.

If they are an individual, this includes their full legal name. If they are not an individual but a business, you will need to include the business or entity designation, which must include “LLC” or “Inc.” in the name in order to provide detailed information.

You will also need to include their full address. If there is more than one borrower, you should include the information of both on the loan agreement.

The lender, sometimes also called the holder, is the person or business that will be providing the goods, money, or services to the borrower once the agreement has been agreed to and signed.

Just like you included the borrower’s information, you will need to include the lender’s information with just as much detail.

Additionally, you will need to include a section that details any guarantor information, if you have one. A guarantor is also known as a cosigner.

This individual or business agrees to pay back the loan in the case that the borrower defaults. You can add more than one guarantor to the loan agreement, but they must agree to all terms set forth in the loan just like the borrower.

Just like you included the borrower’s information, you will need to include the information of each guarantor, and they must sign the agreement. You will need to include their full legal name as well as their full address.

If you do not include a guarantor, you will not need to include this section as part of the loan agreement. Lastly, you will need to include a section that includes the date and location of the signing of the agreement.

In this section of the loan agreement, you will need to include various information such as the date the agreement is effective, the state where any legal proceedings are required to take place, and the specific county within that state.

This is important because it details when the loan agreement is active and will prevent you from having to travel to another place if there are any disputes or nonpayment on the agreement.

The Specific Loan Details

Once you have the information about the people involved in the loan agreement, you will need to outline the specifics surrounding the loan including the transaction information, payment information, and interest information.

In the transaction section, you will detail the exact amount that will be owed to the lender once the agreement has been executed. The amount will not include any interest that will accrue during the lifetime of the loan.

You will also detail what the borrower is getting in return for this sum of money that they are promising to pay to the lender. In the payment section, you will detail how the loan amount will be repaid, the frequency of the payments (e.g. monthly payments, due on demand, one lump sum, etc.), and information on the acceptable payment methods (e.g. cash, credit card, money order, wire transfer, debit payments, etc.). You will need to include exactly what you will accept as a form of payment so there is no question on the forms of payment allowed.

In the interest section, you will include information for any interest. If you are not charging interest, then you will not need to include this section.

However, if you are, you will need to detail the date when the interest on the loan will begin to accrue and whether the interest will be simple or compound in nature.

Simple interest is calculated on the unpaid principal amount while compound interest is calculated on the unpaid principal and any interest that is unpaid.

Another aspect of interest you will need to detail is if you will have a fixed or variable rate of interest.

A fixed rate interest loan means that the interest rate will stay the same during the lifetime of the loan, whereas a variable rate loan means that the interest rate can change over time based on certain factors or events.

You may also want to include information about prepayment in case the borrower is interested in paying the loan off early. Many borrowers are concerned about prepayment and you would be wise to include a clause in your loan agreement that talks about prepayment options, if any.

If you are allowing prepayment, you will need to include this information and detail if they are allowed to prepay the entire amount or only a partial amount, and if you will be requiring a prepayment fee if they choose to do so. If you are requiring a prepayment fee, you will need to detail how much that will be.

Traditionally, lenders require that a percentage of the principal is paid early before they can pay the remaining balance. If you are not allowing prepayment, then you will need to detail that it is not allowed unless written permission is provided by you, the lender.

Securing the Loan and Dealing with a Violation

You have the option of requiring collateral in exchange for your loan. If you wish to do this, then you need to make sure you include sections that address this.

For collateral, if you are requiring it to secure the loan, you will need to have a specific section. Collateral would be an asset that is used as a guarantee of repayment.

Examples of assets that can be used include real estate, vehicles, or other valuable goods. If you are requiring collateral, you will need to identify all collateral that is needed to secure the agreement. Another section you need for this is one regarding the security agreement. If you are not requiring collateral, then you can omit this from your loan agreement.

Signing Date

In regard to the collateral, if each party is signing a separate security agreement for it, then you will need to include the date that the security agreement is signed, or will be signed, by each party.

No one ever thinks that the loan agreement they have will be violated, but if you want to make sure that you can deal with the matter in case the terms are not followed, then you need to have something addressing it.

This is just one reason why it is so important to include this section no matter what. Typically, lenders include a personal recourse provision. This will allow the lender to seek recovery from the personal assets of the borrower if they violate the agreement.

Additionally, you should include the number of days that the borrower has to remedy any breach of the agreement.

If you include this, you cannot provide notice of recuperation until this time frame has passed. It does not, however, prevent you from reaching out to them for an update. The notice period that is standard is 30 days, but you can adjust this as you see fit.

Make sure you include all of these details in this section so there is no question about the actions you should be taking in case you are not paid back by the borrower.

Additional Items

In addition to the main sections detailed above, you have the option of adding additional sections to address specific items as well as a section to make the validity of the document unquestionable.

Every loan agreement is different, so use the additional terms and conditions section of the agreement to include any additional terms or conditions that have not yet been covered. In this section, you will need to include complete sentences and ensure that you do not counteract anything that has previously been put in the loan agreement unless you are stating that a specific section is not applicable to this specific loan agreement.

When executing your loan agreement, you may be interested in having a notary notarize it once all parties have signed, or you may want to include witnesses. The benefit of including a notary is that this will help prove the validity of the document in case it is ever disputed. Having a witness is an alternative to having the document notarized in case you do not have access to a notary; however, if possible, you should always try to include both.