What to check in a personal loan agreement

The most critical part of any loan is the cost of borrowing. You must determine if the interest rate is fixed, meaning it stays the same, or variable, which fluctuates based on market indices like the LIBOR or the Prime Rate.

Always look for the Annual Percentage Rate (APR) rather than just the nominal interest rate. The APR includes the interest plus mandatory fees, providing a more accurate picture of the total cost over a year.

• Check if interest is calculated on a reducing balance or flat rate.
• Verify the frequency of interest compounding.
• Identify the benchmark index used for variable rates.
• Compare the APR against market standards.
• Look for interest rate caps on variable loans.

The agreement should clearly outline when payments are due and how they should be made. This includes the start date, the frequency of installments, and the final maturity date of the loan.

Prepayment clauses are often overlooked. Some lenders charge a fee if you pay off the loan early, as they lose out on expected interest. In many jurisdictions like the EU and India, there are limits on how much a lender can charge for early repayment.

• Confirm the monthly due date and grace periods.
• Check for 'lock-in' periods where prepayment is prohibited.
• Look for specific prepayment penalty percentages.
• Ensure the method of payment is convenient for you.
• Verify if partial prepayments are allowed to reduce principal.

If the loan is secured, the agreement will describe the assets you are pledging as collateral. This could be a vehicle, property, or savings account. If you default, the lender has the legal right to seize these assets.

Unsecured loans do not require collateral but typically carry higher interest rates. Even in unsecured loans, check for a 'negative pledge' clause, which prevents you from pledging your assets to other lenders while this loan is active.

• Clearly identify which assets are being used as security.
• Understand the process the lender must follow to seize collateral.
• Check for 'cross-default' clauses involving other loans.
• Verify how and when the security interest is released.
• Look for requirements regarding collateral insurance.

Lenders often include various administrative fees that can add up quickly. These might include processing fees, documentation charges, and maintenance fees. These should be disclosed upfront in a transparent manner.

Late payment penalties are also significant. Ensure the penalty is a reasonable percentage of the overdue amount and not a flat fee that is disproportionately high relative to the loan size.

• Search for hidden 'origination fees'.
• Check the cost of bounced check or failed transfer fees.
• Review the penalty for missing a single payment installment.
• Look for fees associated with changing the loan terms.
• Verify if there are annual service charges.

The 'Events of Default' section defines what actions allow the lender to demand immediate full repayment. This usually includes missing payments, but can also include providing false information or filing for bankruptcy.

Dispute resolution clauses determine where and how legal battles occur. In the US, many agreements mandate arbitration, while UK and Indian agreements may specify particular court jurisdictions.

• Read the definition of a default event carefully.
• Check for a 'cure period' to fix a default before acceleration.
• Identify the governing law of the agreement.
• Look for mandatory arbitration or mediation requirements.
• Check if the lender can recover legal costs from you.