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While getting a business loan, often, borrowers pay utmost attention to the loan amount, rate of interest, tenure, etc. They also compare loan approval offers received from various banks and NBFCs. However, one thing that borrowers tend to ignore is the business loan agreement. It is a crucial document that the borrower signs at the time of taking a loan. This article explains what a business loan agreement is, its importance and clauses that one should carefully read.
What is a business loan agreement?
In simple terms, a business loan agreement is a legal document drawn between a lender and a borrower and elaborates on terms and conditions that each party has to adhere to. It mentions the amount of loan, tenure, rate of interest, collaterals, and other details of the borrowed business loan. The document also contains terms and conditions if the borrower fails to repay and even pre-payment conditions.
Whether you are taking a business loan from a bank like Axis Bank, HDFC, State Bank of India or from non-banking financial companies (NBFCs) like Bajaj Finance, etc., the format of the business loan agreement remains more or less the same.
What are the important clauses of a business loan agreement format?
Here are some important clauses and elements included in the business loan agreement.
- Details on loan amount
- Details on the loan tenure
- Rate of interest and a clause on change of interest rate
- Repayment schedule and EMI
- Details regarding collateral
- Clauses on defaulting
- Pre-payment clause
- Role of guarantor
Clauses of the agreement may change as per the type of business loan you are seeking such as involvement of collateral, the role of guarantor, etc.
Important clauses that you should not ignore
It is important to read the business loan agreement thoroughly. However, here are some of the important clauses of a business loan agreement, a borrower should pay attention to:
- Loan amount: Check if the loan amount is mentioned correctly in the business loan agreement. In rare cases, there could be an error here. If that is the case, you are promising to pay the wrongly mentioned amount to the bank of NBFC. Therefore, it is recommended to check before signing the document.
- Rate of interest and fluctuations clause: There are usually two kinds of the rate of interest – fixed and floating. You need to check with your lender about the type of interest rate applicable to your business loan. Also, the agreement usually mentions the initial rate of interest. The clause of interest rate will elaborate on in what circumstances the rate changes and its impact on the repayment.
- Tenure and repayment schedule: The business loan agreement will also mention the tenure of the business loan and how it is to be repaid by the borrower. Again, verify if it is the same as what was told to you by the bank official. In rare cases, it may vary. If it does, bring it to the lender’s notice.
- Pre-payment penalty clause: Many lenders charge a pre-payment penalty in case you are making an early repayment. Many borrowers usually miss out on this clause. It results in unpleasant surprises later. Therefore, read the agreement and check what penalty will be imposed on you in case of pre-payment. This also helps you to decide if it is viable to make early payments and pay EMIs as per the schedule.
- A clause on collateral: In case you are taking a collateral loan, check if the information on collateral is rightly mentioned. In case, it is otherwise (a collateral-free loan), ensure that the business loan agreement does not mention it.
- Defaulting clause: Read the defaulting clause carefully. It defines what non-payment or defaulting of the business loan Additionally, this clause also elaborates on a penalty to be paid if the borrower delays the payment of EMI. Read these terms and conditions carefully. So that you are aware of the definition of non-payment and also the penalty it attracts.
- Role of the guarantor: In case the guarantor is involved, this clause defines his/her role in the business loan repayment process. Most of the time, the guarantor is liable to repay the loan in case the borrower fails to do so. You need to read this clause carefully before signing the business loan agreement as it puts the guarantor in a difficult position in case you fail to repay.
Business loan agreement vs promissory note
Does the business loan agreement seem the same to you as a promissory note? Although business loans and promissory notes may have several similarities, they are fundamentally different in nature. Both agreements have different legal standings.
For example, a promissory note is an informal document and may have limited remedies in case the borrower defaults on repayment. Here is a difference between a business loan agreement and a promissory note:
|Business loan agreement||Promissory note|
|It is more formal in nature||It is still informal|
|Collateral||A business loan agreement may or may not involve collateral depending on the type of the loan||A promissory note does not involve any collateral|
|Legality||It has binding requirements for both the parties – borrower as well as lender||Usually, it encompasses legal bindings limited to the borrower.|
|Repayment||Clause suggests equated monthly installment (EMI)||Promissory note normally has a clause of lump sum repayment|
|Use||It is used by banks and NBFCs while disbursing any kind of a loan||It is usually used for seeking a loan from friends, families and peers|
|Pre-payment penalty||Pre-payment may be charged by the lender||There is no involvement of a pre-payment penalty|
In simple words, a business loan agreement is an elaborated document. By signing this document, you promise to adhere to the terms and conditions mentioned in the document. As a result, it is necessary to read and understand each clause.