A Credit Agreement is a legally binding contract between a bank and a client where the client is in need of a particular kind of loan offered by the bank. These are bipartite agreements and there are certain terms and conditions which need to be discussed before the agreement is drawn. The borrower has to read the terms of the contract and sign it indicating his agreement with the terms and conditions.
These agreements can be made against any type of loan namely mortgages, auto loans, and credit card loans. There are a lot of factors that decide the terms of the loan which need to be considered before the agreement is finalized. The financial institutions have a credit agreement template according to the type of credit being availed of by the client.
When Do You Need a Credit Agreement
A credit agreement is required when the client wants to take a loan to avail certain benefit, which could be a product or a service. The purpose of credit agreement is to ensure that the borrower gets the type of loan required at the rate of interest and a duration suitable for him or her.
The agreement takes into account a lot of information regarding the credit history of the borrower and previous payment record, if any. Then, depending on the duration of the loan and the amount borrowed, the interest rate is decided. The borrower can try to negotiate the terms of the loan before the agreement is drafted and try to finalize on mutually agreeable conditions.
Inclusions in Credit Agreement
With the credit agreement being a bipartite agreement, the names of the borrower and lender must be part of the agreement. The Credit Agreement must have the effective date of the agreement, the amount of the loan being taken including the rate of interest, the type of loan being taken, the duration of the loan and the credit history of the borrower.
The repayment schedule of the loan, penalties on default and clauses relating to prepayment must be included in the agreement. The details of the collateral being provided also need to be mentioned. The credit agreement also contains an escalation clause even in case of a fixed interest agreement after a certain period. The rights and liabilities of the borrower and the lender are also included in this agreement. The events which lead to cancellation of the agreement are also stated.
How to Draft Credit Agreement
There are some important factors that need to be considered while drafting a credit agreement. They are:
- The names of the parties to the agreement and the relationship between them need to be clearly mentioned
- The amount of loan being taken as well as the type of loan has to be stated.
- The interest rate being charged for the loan as well as the inclusion of an escalation clause for any changes depending on future interest rates needs to be mentioned. The method of interest calculation must be shown clearly
- The duration of the loan as well as the prepayment clause, if any, should be part of the agreement
- The events which lead to default need to be stated clearly
- The governing law and the jurisdiction of the agreement are very important
Benefits of Credit Agreement
According to the credit contract definition, it is an agreement between a borrower of a loan and a lender. The benefits of having a Credit Agreement are as under:
- The type of loan, as well as the amount of loan, interest and payback period, are clearly mentioned in such agreements. This ensures there is no dispute at a future date as the terms and conditions are mutually agreed upon when signing the agreement.
- Since the lender of the loan is provided collateral by the borrower, hence they are protected in case there is a default by the borrower.
- The borrower is clear about the terms of the loan before signing the agreement.
Types of Credit Agreement
There are different types of credit agreement depending on the type of loan being issued to the customer.
- Credit cards: This type of loan entitles the borrower to take a loan subject to a certain limit from the financial institution. The limit is revised according to the repayment record of the borrower. The interest rates are very high.
- Personal Loans: Personal loans are taken by borrowers to tide over a sudden emergency or go for a home renovation. These loans are taken for a very short period of time with high rates of interest.
- Mortgage Loans: These loans are high value loans which are taken for the long term, and the interest rate depends on the duration of the loan
- Revolving credit accounts: In such credit agreements, the amount drawn each month depends on the customer’s cash flow needs.
Key Terms of a Credit Agreement
The key terms of a credit agreement are:
- Interest rate: This is an important component of a credit agreement. There are mainly two types of interest, namely fixed rate of interest and floating rate of interest.
- Default interest: This refers to the interest penalty payable by borrowers if the loan instalment is not paid on the due date.
- Prepayment: The agreement should contain a prepayment clause which enables the borrower to repay the loan early.
- Events of default: The terms and conditions under which the borrower is deemed to have defaulted on the loan need to be stated
- Committed or Uncommitted loan agreement: In a committed loan agreement, the lender is obliged to extend the loan.
Sample of Credit Agreement
When a customer wants to avail of a loan from a bank, then a Credit Agreement is extremely important.
You can download a credit agreement sample here.