-A loan transaction often requires the signing of paperwork to formalize the contract. A clear understanding of the relevant documents is usually a perfect starting point.
For instance, promissory notes and loan agreements are vital documents for detailing lending terms. A promissory note is ideal for personal lending agreements, while a loan agreement is suitable in a formal set-up involving a financial institution.
Read on to understand how the both documents work and the factors to consider before choosing a loan agreement.
When Do You Need a Promissory Note?
A promissory note is a negotiable financial instrument governing a loan agreement. It contains a promise to pay the loan amount over an agreed time.
Although a promissory note is a legal document, it is more informal and often involves people who share a cordial relationship. It is, therefore, effective when lending or borrowing a small sum from a friend, staff colleague, or relative.
When Do You Need a Loan Agreement?
A loan agreement is similar to a promissory note except that it is more formal and detailed. Loan agreements are of two types: secured and unsecured.
A secured agreement grants the lender the legal right to recover an asset used as collateral to recover the debt. An unsecured loan agreement, on the other hand, doesn’t have collateral. So, if you breach the contract, the lender can’t assume rights to your assets but seek legal redress.
A loan agreement contains the following essential information:
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Loan amount
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Due date.
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Installment dates (if any).
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Interest payable.
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A loan agreement is suitable for large sum of money since it creates legally enforceable contracts with penalties for nonpayment. Such transactions include car loans, mortgages, or lending substantial cash to known borrowers. You may also need a loan agreement if you don’t share a cordial relationship or mutual trust with the borrower.
Important Considerations Before Choosing a Loan Document
You may often wonder if you should use a promissory note or loan agreement for your transactions. After all, both documents are legal contracts with terms and obligations to both parties. The following factors will help you choose a suitable loan document:
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- Loan Amount
- Repayment Terms
- Remedy for nonpayment
Generally, if you borrow a small amount from a friend, you build on trust, and a promissory note will suffice. However, if the transaction is larger and you’re not familiar with each other, a loan agreement will help you seal the contract.
A loan agreement contains stringent terms, including restrictions and financial obligations. Quite often, it also includes collateral to back the loan. On the other hand, a promissory note is flexible, relaxed, and friendly. A loan agreement will suffice if you want to enforce strict terms on the lender.
A promissory note may not contain a remedy for nonpayment, especially if both parties have a close relationship. However, a formal loan agreement allows you to foreclose on the collateral if the borrower can’t pay the loan.
Promissory notes and loan agreements offer payment security to the parties involved. They highlight loan terms and the relevant consequences for defaulted obligations. So, if you want to lend money to someone, take advantage of the free promissory note or loan agreement from Forms.Legal for all USA states.