For lending that is not covered by formal or regulated agreements such as bank loans or mortgages, the borrower and lender will need to come up with their own terms and put them in writing.
What are some examples of less formal lending?
This may cover the following:
– A loan to your child or family member to buy a home
– A loan to a friend who wants to start a new business
– A loan for a business partner to pay for their capital in the business
Whatever the scenario, it is extremely important to record the amount and relevant terms of the loan in a written agreement. Templates can be found at sites such as The Law Depot which can be a helpful starting guide if you need to write a https://www.parachutelaw.co.uk/loan-agreement.
What your loan agreement should consider
In agreeing the terms of the loan, you should consider factors such as how likely it is that the borrower will repay on time, the potential that their financial situation could change and how important it is to you to obtain the most favourable interest rate. Also, you will need to determine whether the amount the borrower is requesting is enough to satisfy their needs, or is there a likelihood that they will need a top-up further down the line. Decide what interest rate you are prepared to lend at, what security can be provided and what will happen if the borrower is unable to repay. This is not an exhaustive list but includes the main considerations.
Security
There are three common methods of securing a loan as follows:
– traceable securities, for example, intellectual property or public company shares that can be sold
– a promise by a third party guarantor to pay or make good if the debtor fails
– goods that are difficult to move, such as plant or machinery
The most important factors for choosing security are:
– liquidity – this is the timescale and ease with which the security can be converted to cash. Consider a tractor vs. a share certificate of 10,000 shares in a FTSE 100 company. No matter how much the tractor may be worth, it will be easier and quicker to sell the shares. Some borrowers will offer the goods they intend to buy with the loan as security, but this is not always possible so do explore whether there are other alternative options for securing the loan.
– its importance to the borrower – something of great personal value to the borrower will mean that their effort to pay back the loan will be greater.
Using property (including buildings and land) as security
Property is not as liquid as many other assets, but as it keeps its value, it is preferable to items such as plant and machinery. Using property as security means a charge will be placed on the property, which is a record of the lender’s details as a party that has a stake in the property. This will need to be arranged formally by a solicitor who registers the charge with HM Land Registry and replaces the previous system where the title deeds could be passed to another owner.
Once you have decided on what form of security is being taken for the loan, this should be recorded in the agreement with the process laid out as to what happens in the event of non-payment. The period of time which constitutes a default will need to be defined in order to trigger any action to call on the security.