Common Mistakes to Avoid When Drafting a Loan Agreement

A well-drafted loan agreement protects both lenders and borrowers by clearly defining the terms of the loan. However, failing to include key details can lead to misunderstandings, disputes, or even financial loss. Here are some common mistakes to avoid when drafting a loan agreement:

1. Not Stating When the Funds Were Lent or Will Be Lent

One of the most overlooked but crucial aspects of a loan agreement is specifying the date the funds were or will be transferred. This ensures clarity regarding when the borrower becomes obligated to repay and helps prevent disputes over whether the loan was actually provided.

2. Failing to Specify the Purpose of the Loan

Clearly stating the purpose of the loan—whether for business investment, property purchase, or personal expenses—can provide legal clarity if disputes arise. Some lenders may also want to impose restrictions on how the borrowed funds can be used, which should be explicitly documented in the agreement.

3. Unclear or Missing Repayment Arrangements

A common mistake is failing to define how and when repayments should be made. The agreement should specify:

• The repayment schedule (e.g., weekly, monthly, lump sum)

• The payment method (e.g., bank transfer, cheque)

• Whether early repayments are allowed and if any penalties apply

Without these details, both parties may have different expectations, leading to unnecessary disputes.

4. Overlooking Default Arrangements

If the borrower fails to make payments, what happens next? Many agreements lack clear default provisions, leaving lenders uncertain about their options. The agreement should outline:

• What constitutes a default (e.g., missed payments, insolvency)

• Any grace period before default action is taken

• Remedies available to the lender (e.g., legal action, seizure of collateral)

5. Not Defining the Term of the Loan

The loan term refers to the duration within which the loan must be repaid. Some agreements lack a clearly defined term, making it difficult to enforce repayment. Ensure the agreement states:

• The loan start and end dates

• Any extension options and conditions

• The consequences of failing to repay within the agreed timeframe

6. When the Loan Must Be Repaid

Many loan agreements fail to specify when the loan must be repaid if significant life events occur. It is crucial to include provisions that clarify repayment obligations in the event of:

• Default – What happens if the borrower stops making payments?

• Divorce or Separation – If the loan involves a couple, how is repayment handled if they separate?

• Death of the Borrower – Does the responsibility pass to the estate, or is immediate repayment required?

Without addressing these scenarios, lenders may struggle to recover the funds or face legal complications.

7. Omitting Interest Rate Terms

If interest applies, it must be clearly outlined, including:

• The interest rate (fixed or variable)

• How interest is calculated (e.g., simple vs. compound interest)

• The consequences of late payments on interest accrual

8. Ignoring Collateral or Security Terms

If the loan is secured against an asset (e.g., property, vehicle, shares), the agreement must specify:

• The collateral provided

• The process for seizing collateral if the borrower defaults

• Whether additional security may be required if the value of the collateral decreases

Without clear collateral terms, enforcing security over the loan may become legally challenging.

9. Forgetting to Lodge a Caveat Over a Security

If the loan is secured by real property, failing to lodge a caveat can be a costly mistake. A caveat acts as a legal notice on the property title, preventing the borrower from selling or refinancing the property without the lender’s knowledge. Without a caveat, the lender’s security interest may be at risk, particularly if the borrower defaults or faces financial difficulties. To ensure proper protection, it is best to have a lawyer draft the loan agreement and advise on lodging a caveat where necessary.

Conclusion

A well-drafted loan agreement minimises risks for both lenders and borrowers by ensuring all essential terms are clearly documented. Avoiding these common mistakes can help prevent legal disputes and financial losses. If you are unsure about drafting a legally sound agreement, consulting a lawyer can provide peace of mind and ensure your funds are protected.