Understanding Borrower’s Obligations in Loan Agreements

If you have borrowed money, or intend to so, it is crucial that you understand what your obligations are under the loan agreement. A loan agreement is a document that outlines key information about the loan, including who the lender is, and who the money is being lent to (‘borrower’). Furthermore, it will outline the obligations on the borrower regarding the loan. Generally, failing to comply with the loan agreement can have serious consequences, and in this way, it is important to be conscious of what your responsibilities are as a borrower.

Common obligations that borrowers must fulfil in loan agreements

Although the objects of each loan agreement will differ, the following responsibilities generally appear in most loan agreements.

Purpose of the loan

In some cases, the borrower must use the loan for a particular purpose only. For example, the loan may be given only to ensure payments are made for the purchase of a house. This will enable the lender to determine how risky a loan is, and therefore, how much the collateral or security ought to be. In addition to this, if the lender is a bank, the purpose of the loan is important in determining whether the National Credit Code (NCC) applies.

The NCC applies where:

  • The loan is given by a bank (or other financial institution);
  • There is an obligation to repay the loan;
  • The loan is given to a ‘natural person’ (an individual),
    for one of the following purposes:
  • Personal, domestic or household purposes, or
  • To purchase, renovate or improve residential property for investment purposes, or to pay loans that were previously given for this purpose.

Provision of collateral or security
Depending on the loan amount, and the likelihood of the borrower being able to pay off the loan (credit risk), the borrower may be asked to provide collateral or security of some sort. Collateral or security refers to an asset (such as a house, car, etc.) owned by the borrower that a lender has an interest over. If the borrower cannot make the repayments on time, or defaults on the loan, the lender can repossess this asset to cover their losses.
Although the collateral/security will be referred to in the loan agreement, it is standard practice for this type of security interest to be governed by a separate document. Usually, this is done in a general security agreement, which is a document signed by the borrower and lender outlining the interest that the lender has in any assets as collateral.

Repayment of the principal loan amount
The borrower must pay back the amount that was borrowed to the lender. This is known as the principal loan amount. The loan agreement will outline when and how the repayments must be made. In most cases, the full amount of the loan must be paid on one date, or it can be paid in instalments over time.

Payment of interest
In addition to repaying the principal loan amount, the borrower may be obliged to pay interest on the loan. The loan agreement will outline what the interest rate is, how this is calculated, and when the interest should be paid. The interest rate will vary depending on a number of factors, including credit risk. Generally, the less credit and debt that borrowers have accumulated over the years, and the more collateral they have, the lower the interest rate is likely to be.
There may also be an obligation upon borrowers to pay default interest if they fail to make a payment on time. This acts as a disincentive to prevent borrowers from defaulting on payments. The default interest rate, and how this is calculated, will also be included in the loan agreement.

Payment of fees, costs and expenses
The borrower is also obliged to pay any lending fees that the lender has specified in the loan agreement. There may also be an obligation upon the borrower to pay for any costs or expenses that have come about in relation to the loan agreement or security documents, such as registration fees, stamping costs and lawyers’ fees. If any of these apply, this will be outlined in the loan agreement.

Financial information
The lender may request the borrower to provide information about its financial affairs on a continuing basis. This can help the lender to determine whether the borrower is in a stable financial position, and is able to make all repayments on time.

Other covenants
The loan agreement may oblige the borrower to follow other covenants. Essentially, covenants are undertakings by the borrower to do or not do something. The overall aim of this is to ensure that the risk of the borrower defaulting on the loan is minimised. Covenants can be divided into two types:
1) Affirmative covenants: Promises to do something. For example, covenants to out an insurance policy, covenants to keep an up-to-date book of account.
2) Negative covenants: Promises to not do something. For example, covenants to not enter into other loan agreements, covenants to not enter into certain investments without notifying the lender.

Consequences of not complying with loan agreement obligations
If a borrower does not comply with one of its obligations under a loan agreement, such as not making a payment on time, this is likely to be classified as a default. Given that a loan agreement is a contract, the lender will have the following contractual rights:

  • The lender can force the borrower to immediately repay the money under the loan, as well as any interest/fees/charges (that have been outlined in the loan agreement);
  • If security or collateral has been provided, the lender can repossess this to cover any losses which may have arisen from the default; and
  • If the loan amount has not been given to the borrower yet, then the lender is not obliged to lend this to the borrower.

Note for lenders: Regardless of whether the NCC applies or not, where a default has occurred, lenders must provide a notice to the borrower. This will outline which obligation the borrower has defaulted on, and the time which will be given for the borrower to rectify the default (usually a minimum of 30 days). If the borrower has not taken action following this time, the lender can enforce their security interest.

Key takeaways

  • Ensure that you understand what your obligations are as a borrower under the loan agreement, including what you must use the loan for, and dates that repayments must be made.
  • Non-compliance with obligations will afford serious consequences to borrowers, including potentially repossession of collateral assets.

If you have questions about your obligations under a loan agreement, get in touch Lord Commercial Lawyer’s loan agreement lawyers on 9600 0162 or email us at info@lordlaw.com.au or fill out the form on this page.