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Before You Sign the Dotted Line, Learn These 34 Key Loan Contract Terms

By James Woodruff Reviewed By Mike Lucas
By James Woodruff
By James Woodruff Reviewed By Mike Lucas

The loan terminology used in a financing agreement can seem confusing. But it’s important to understand the terms related to loan provisions before you sign on the dotted line. 

Here’s a list of the most important terms for the various parts of a business loan agreement you need to know.

1. Annual Percentage Rate

The annual percentage rate is the total cost alone. It includes the base interest rate plus other financing fees. For example, many lenders charge a loan origination fee. This fee must be included in the total financing cost of the loan contract, so the borrower knows exactly how much they’re paying. 

2. Borrower

A borrower is a person or corporate entity that has applied for a loan and received the funds. The borrower is obligated to repay the loan.

3. Borrower Default

A loan default takes place when the borrower fails to make payments in accordance with the loan agreement. Most loan agreements have a few days grace, but if the borrower fails to make payments for several months, the lender will begin to take steps to collect the debt and report the delinquency to the credit-ranking firms. 

4. Collateral

Collateral is an asset that a lender can use to secure a loan. For example, an automobile can be used as collateral to finance its purchase. If the borrower defaults on the loan, the lender then can seize the collateral and sell it to help pay off the balance of the loan. 

5. Co-Borrower

A co-borrower is someone who accepts joint responsibility with another person to pay back a loan. Vendors will check the credit histories of all co-borrowers to approve the loan. The names of co-borrowers will appear on the loan agreements. 

6. Co-Signer

A co-signer is someone whose credit history may be used to help a person with a lower credit score to qualify for a loan. If you co-sign a loan, you are agreeing to pay the outstanding balance in the event the original borrower defaults on the payments.

7. Covenants

Some loan agreements may have special agreements that are unique to the situation. For example, a lender may require that the borrower not pledge any assets to another lender or take out additional loans while the lender’s is outstanding.

8. Credit Score

A lender will check your credit score to evaluate the risk of giving you a loan. People with higher credit scores are more likely to get approved and receive lower interest rates.

Scrabble letters on a game board spell out “Loan Terminology.”

9. Default Interest

The default interest rate comes into effect when the borrower has missed several loan payments. It is a higher rate than the loan rate stated on the agreement and is intended to compensate the lender for the lost investment opportunity of missed payments.

10. Default Events

An event of default is described in the loan agreement and allows a lender to demand full payment of the loan balance owed before its due date. Examples of default events are defaulting on payments, violations of loan covenants and filing for bankruptcy protection.

11. Fees

Lenders frequently charge fees to set up a loan. A loan origination fee is one example. An appraisal fee for real estate is another. These fees should be included in the calculation of the annual percentage rate. 

12. Fixed Interest Rate

A fixed interest rate is an interest rate that doesn’t change for the life of the loan. Those with fixed interest rates usually have fixed payments of principal and interest for the life of the loan.

13. Grace Period

Some loan agreements let you make a payment a few days after the due date, known as a grace period, without incurring a late fee.

14. Hard Credit Check

A hard credit check happens when you apply for a loan and the lender checks your credit history with the credit-reporting firms. A hard inquiry will have a small negative impact on a credit score for a few months. If you’re applying to several lenders, it’s better to make all applications in a short period of time to minimize the negative impact on your credit score. 

15. Installment Loan

An installment loan is one that you pay back with fixed payments of principal and interest over a specific term. Examples would be loans for automobiles, mortgages and personal loans. Installment loans can have repayment terms from a few weeks up to 30 years. 

16. Interest

Interest is the cost of borrowing money. You will pay interest from the time you receive the funds until the loan is completely paid. 

17. Jurisdiction

In the event of default or other legal issues, the loan agreement will usually specify that the governing laws will be those of the jurisdiction where the lender resides.

18. Late Fees

The lender will charge late fees if you make a payment after the due date. Late fees must be outlined in the loan agreement. 

19. Loan Amortization

Loan amortization is the process of paying off a debt with equal installments over time. A portion of each installment goes to pay interest and reduce the principal balance until the debt outstanding is reduced to zero at maturity.

20. Loan Agreement

A loan agreement is a document that outlines the terms of the loan and the responsibilities and obligations of the lender and the borrower. A borrower should thoroughly read a loan agreement to be sure that they understand all of its terms and requirements. 

21. Loan Deferment

If you are having difficulties making payments on your loan, your lender may grant you a loan deferment. If a deferment is approved, you would be able to defer loan payments for a certain period of time without the loan being declared in default. This would allow you to solve your temporary cash-flow problems and let you resume payments without penalties. 

22. Loan Limit

Loan limits usually refer to the conforming loan limits of Freddie Mac, Fannie Mae and FHA. These are the maximum loan amount that each organization is allowed to back or guarantee. The current conforming loan limit for Freddie Mac and Fannie Mae is $548,250, and the FHA limit for a single-family house for the majority of counties in the U.S. is $356,362.

23. Loan Origination Fee

In addition to charging interest, lenders might charge various fees to set up a loan. These charges could be called fees for origination, processing or document preparation. They can be charged as a percentage of the loan amount or as a flat rate.

A business owner inspects a paper labeled “Loan Contract” with question marks swirling around his head.

24. Nonrecourse Loans

Nonrecourse loans are loans that are secured by specific collateral, such as a piece of real estate. If a borrower defaults on a nonrecourse loan, the lender’s ability to seize assets of the borrower is limited to taking possession of the collateral assigned to the loan. The lender can’t attempt to take possession of other assets of the borrower. 

25. On Demand

A demand loan is when a lender can require that a loan be repaid in full at any time. The borrower also has the option to repay the loan at any time without any prepayment penalty. Borrowers use demand loans to fund short-term working capital needs. 

26. Prepayment penalty

Some loans may impose a prepayment penalty if you pay off the loan balance before the loan’s due date. Lenders make a profit on the interest they charge on a loan, and a prepayment penalty is intended to make up for the interest the lender loses if you prepay the loan. 

27. Principal

The principal of a loan is the amount you borrow from a lender. The lender charges interest on that principal amount. 

28. Recourse Loans

A recourse loan gives a lender a substantial advantage: If a borrower defaults on a loan secured with collateral, such as a vehicle, the lender can seize the collateral and sell it and apply the proceeds to the outstanding loan balance. If the sale of the collateral wasn’t sufficient to pay off the loan, the recourse provision would give the lender the right to go after and seize other assets of the borrower to pay off the deficit.

29. Repayment Plan

A loan repayment plan specifies how a loan is to be repaid. It would state the amount and number of the payments and over what time period. 

30. Secured Loan

A secured loan has collateral as a backup that the lender can seize if the obligor defaults on the loan. Collateral could be assets such as real estate, machinery or vehicles. As for interest rates, secured loans usually are lower than unsecured loans because they have fewer risks for the lender. 

31. Severability

Severability is a legal term for contracts which states that if one portion of a contract is found to be unenforceable or illegal, the remaining provisions of the contract are still valid and applicable. 

32. Soft Credit Check

Soft credit checks are usually for informational purposes, such as inquiries by landlords, employers or preapprovals for credit card offerings. Unlike a hard credit check, a soft inquiry doesn’t affect your credit score. 

33. Unsecured Loan

An unsecured loan relies solely on the willingness of the borrower to repay the loan. If the borrower defaults, the lender doesn’t have any collateral to seize.

34. Variable Interest Rate

Some loans charge interest at rates that vary over time. For example, a business loan could have an interest rate set at 2 percentage points over the prime rate, and the rate would change each time there was a change in the prime rate. Another example could be a business loan with the interest rate set at certain percentage points over the London Interbank Offered Rate (LIBOR), but the rate would only be changed on a quarterly basis.

James Woodruff Contributing Writer for Fast Capital 360
James Woodruff is a former management consultant and now uses his experience to write business-related articles for Fast Capital 360. He has written extensively for Bizfluent and Small Business - Chron.
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