Your Guide to Loan Agreements in Texas
A loan agreement is a legally binding contract, created when one person or entity lends something of value to another person or entity, allowing the borrower to do something that they would not have been able to do otherwise. A borrower receives a product, service, money, or access, and simply promises to pay back the value of their loan according to the terms and conditions set forth in the agreement.
The elements of a loan agreement include: While there is no specific state law requiring the use of loan agreements in Texas or any other state , the Commercial Code does require the use of a written contract if there is a sale of goods for over $500 or a transfer of any interest in real estate. However, even a small loan, without interest or collateral, can benefit from the protection of a loan agreement. A loan agreement can set out the terms of repayment, making it clear what happens if a borrower defaults on their payment. Without this sort of documentation, the lender has no legal recourse and cannot take collection action against a borrower who fails to pay them back.
Key Parts of a Loan Agreement in Texas
Every loan agreement in Texas should contain the following elements as a starting point:
Parties: Properly identify all of the parties to the agreement. An agreement signed by the borrower and a joint owner may be binding, but there are potential larger issues if it is later contested (when the borrower defaults).
Amount: The agreement should specifically state how much the borrower is borrowing. The borrower may be tempted to later alter this number for his or her own purposes.
Repayment Terms: How will the borrower pay back the loan? Including this information in the loan agreement up front can eliminate any dispute between the parties later (especially in a community property state such as Texas).
Interest: The agreement should specify the interest rate with which the borrower must repay the lender. A new Texas legislature law requires all loans to be capped at a 10% annual interest rate, unless the Annual Percentage Rate is greater than 18%. However, the Federal Trade Commission, Internal Revenue Service, and the Office of Thrift Supervision are also able to assess whether or not an interest rate charged on a loan in Texas is considered excessively high. This section may vary depending on what you would like the borrower to pay to you.
Default: In this section of the agreement, you should exactly explain the consequences of the borrower’s possible default on the loan. Will the lender be able to take the property used as collateral under the loan? Will the borrower have the ability to refinance with a different lender?
Additional components of a fully executed loan agreement are the signatures of the parties involved. The lender and the borrower should both sign the agreement, and it should be notarized. It’s a good practice to have two witnesses sign the agreement as well.
Texas Loan Agreements: What the Law Requires
In Texas, the Statute of Frauds requires that all contracts and agreements for the sale of real property be in writing and signed by the parties that are bound. Certain other contracts, including agreements or promises to perform an act after death, must also be in writing. This secures the enforcement of the terms of the written agreement, however informal they are. The agreement and any necessary addenda must be signed and dated by both parties. Failure to do so can result in a forfeiture claim under Texas Civil Practice & Remedies Code § 16.004. Loan agreements secured by real property must be in writing according to the Texas Real Estate and Business Opportunity Disclosure Act. The deed of trust must be signed by the borrower and a third party, often a title company that has resourced the notarization for validity. Additionally, it is required to be filed in the real property records of the county (or jurisdictions) in which the contemplated property is located. All loan agreements that extend payments or interest on moneys exceeding $100.00 per month for one year or longer must follow these regulations. Loan agreements not secured by real property are not required to be recorded with the local courthouse, but they can still be recorded at a county or state level to protect both the lender and the borrower against claims by outside creditors if there is a default on the loan. Financing contracts, sale contract money, and chattel mortgage loans and contracts are all subject to different rules when it comes to how the loan agreement is interpreted and enforced. Loan agreements secured by real property are governed by Chapter 26 of the Texas Business and Commerce Code. Agreements for the purchase or lease-purchase of goods are subject to these laws as they will be enforced upon the failure of either party to perform their duties of any Texas loan agreement.
Drafting a Template for a Loan Agreement in Texas
Once you have selected a template that fits your needs, it’s time to customize it.
There are several contexts where a loan agreement may be necessary in Texas. A personal loan may be made between individuals such as family members, friends or colleagues. Or a more formal business loan agreement may be appropriate. These may involve commercial banks or smaller institutions such as credit unions and venture capital firms. Where the loan is for a house or other real estate, the lender may require a mortgage or deed of trust.
Because there are so many variations, most professionals will not use an online template "as is," but adapt to their own situations. Some of the areas that you may wish to tailor could include:
Authority – Is the person or business that is borrowing authorized to enter into a loan agreement? If so, is it a managing member, a director or officer, or perhaps even a partner? As a borrower, be certain that you have the authority and, as a lender, that the borrower has provided proof.
Repayment – How will the loan be repaid and at what times? It may be monthly or it may be quarterly. Will the loan and interest be paid back in a lump sum or in installments?
Loan Amounts – Again, the loan agreement should be specific not only in amounts, but in terms of when the money will be disbursed.
Business – Will the loan be made to an individual or a business? If the loan will be to a business, is the entity active and compliant with Texas law?
Financial Assistance – Financial assistance from the state, federal or local government may be provided to encourage the development of an area or promote a business.
Timing – Has the loan been made at the correct time? You may wish to insert a clause prohibiting the parties from entering into a loan transaction without the consent of the other party if the parties are involved in a merger or similar type of agreement.
These are just some of the aspects of a loan agreement that could be customized.
Avoiding Mistakes
One of the most common mistakes I see in those who prepare their own loan agreements is that they fail to include dates. Many of the loan agreements we come across that are prepared by the parties themselves are completely unsigned. The parties to the contract may have an "agreement" orally or via text, but without a signed written document they are without any real liability against a borrower. If the lender needs prompting the borrower to sign the loan agreement template, simply allow them to take a photo on their phone of the unsigned agreement and text it to them as a reminder to add their signature. Once they have signed the agreement, their deposited check will make them much less likely to forget the terms of the agreement.
The loan agreement template should be as specific as possible regarding the terms of repayment and date, dates, payments, and fees. For loans between parties who have never borrowed or loaned one another money, it is best to treat all your clients equally by having a set of terms that are always included in the loan agreement template and simply edit the blanks for things like payment terms and interest rate. Often the parties lend money to one another without regard for the interest and penalty provisions , thinking they can sort it out on the fly if it becomes necessary. This only results in confusion later when emotions run high during the dispute process.
A common problem I run into with loan agreements is the failure to include protections for the loaned funds, meaning the agreement should address what happens if the borrower does not repay the money as agreed – particularly the due on sale clause and right to collect attorney fees. Without a properly drafted loan template, a mistaken understanding of the agreement may leave a lender without the legal right to recover his or her money. The most common problem with this that I see is in the sale of real estate and a failure to include the due on sale clause in the loan template.
I have seen criticism of those who draft their own documents from the standpoint that the documents are never going to be as good as the ones prepared and sold by lawyers. Particularly in business formations, this may be true, but the loan agreement template should be a fairly routine matter. Small dollar amounts, or individuals lending to one another rather than lending as a business, are probably safe drafting their own loan template if they keep certain principles in mind. Be careful when doing any renovation work on the template, however, when it involves something outside of the norm for a loan.
Texas Loan Agreement Templates: The Pros and Cons
Using a free loan agreement template is a good idea if you want to ship an otherwise complicated legal task to someone else and get back something for a low cost; however, ultimately it’s much better if you create your own from scratch. For a typical loan agreement, that means having an attorney write one up for you.
Loan agreement templates have several advantages. As mentioned above, you simply fill in the blanks and you have a legal document without putting too much thought into it. If you remember to bring up all the right topics and enough information when drafting, the end product might actually be fairly useful. Of course, the problem comes up if you don’t really know what you’re doing or have experience drafting a loan agreement. You could miss critical details or, worse, expose yourself to potential liability.
For example, there are a lot of problems that can come up involving secured loans and secured loans. Some templates do a pretty good job covering this. Others do not. If your template does not and the deal does turn sour, then your original-seller may now actually have become the owner of some of your property. This is not good. There are lots of additional pitfalls like this that novice drafters may unwittingly create for chance encounter with a risk adverse judge.
A loan agreement template is also a bad idea when it comes to protecting lender priority. When a lender gets a loan on a timely basis, they often enjoy priority over other creditors with respect to certain assets. A template often does not do a good job of making sure that the lender has the unconditional right to take possession of the designated assets in the event of default.
The general rule of thumb: if your document is for a minor transaction that won’t have any significant consequences if it contains some errors, then by all means use the loan agreement template. On the other hand, if this is an important deal where a mistake could cause serious financial damage, consult an attorney for some proper advice.
Perfecting and Enforcing a Loan Agreement in Texas
Loan agreements in Texas must be in writing to be enforceable. That satisfies the statute of frauds (chapter 26 of the Texas Business and Commerce Code). Other than that, there are not many special requirements for formally finalizing and signing a loan agreement in Texas.
In practice, the parties will sign an agreement to pay (usually) with both parties’ signatures, although only one party needs to sign a note signed by the debtor for the loan agreement to be enforceable. I generally look for the signatures to both parties, so that I have a signature of the creditor. If a company is the creditor, then the person signing on behalf of the creditor company should have authority to bind the company. It’s especially good to have the name and title of the signer next to their signature, so that it is clear they are signing as agent and not personally. I typically like to have both parties initial all pages of a loan agreement (not the attachment pages) to ensure that every page of the agreement is considered by both parties.
The creditor should make sure to get a copy of the loan agreement signed by the debtor at the time the debtor signs , rather than emailing or faxing the agreement to the debtor after the debtor has already received funds. That way, creditors can be sure that the debtor has the signed agreement before the debtor signs.
A default on the loan agreement’s terms may be grounds for the creditor to seek to enforce the agreement against the debtor in court. A creditor may want the court to order the debtor to comply with the terms of the agreement. Or, the creditor may want the court to award damages to the creditor for the harm caused by the debtor’s breach of the loan agreement. Since a loan agreement in Texas is a type of written contract, the creditor could also ask the court to order the creditor to take possession of collateral that is security for the debt.
When enforcing the loan agreement, the creditor may need to record the agreement and a UCC-1 financing statement to secure its interest in collateral in the county in which the collateral is located.