The 3 most important parts of a personal loan agreement, according to an expert

Reading a personal loan agreement is kind of like reading a CVS receipt: It’s very long, full of words that don’t really matter, and not particularly enjoyable.

Unlike a CVS receipt, a personal loan agreement comes with real stakes that are important to understand. That’s because a personal loan agreement is a legal contract between you and your lender explaining your loan’s borrowing and repayment conditions. While they aren’t entertaining reads, the details of your loan agreement will affect the total cost of your loan and how you repay it. Understanding the terminology and conditions of your loan will help you make responsible borrowing decisions.

Loan agreements are not written for you

I talked with Denny Ceizyk, a former mortgage lender and current senior writer with Bankrate, to learn how an expert reads a personal loan agreement. Ceizyk has over 30 years of combined experience with loans, including loan sales and writing personal finance articles.

Unfortunately, loan agreements aren’t written for borrowers. Lenders use legal language that’s unfamiliar to many people outside the lending industry, leading to confusion and misunderstandings. Thankfully, Ceizyk tipped me off about key features to look out for.

Take these three steps before you sign

1. Check the payment schedule

Most personal loans are fixed-rate installment loans. Their interest rate and monthly payments will remain the same throughout the loan’s life. This predictability is one reason personal loans are popular; they’re easy to budget for and have a set number of payments until payoff.

There are lenders who use other structures, though. “If it’s a fixed-rate loan, all of the payments should be the same until the loan is paid in full,” Ceizyk explains. “Watch out for balloon payments or prepayment penalties that are typical of predatory loans.”

Signs of predatory repayment plans

Balloon payments attract borrowers with small payments early in the life of the loan, gradually increasing over time. Later, outsized payments are substantially larger, often leading to incomplete payments, penalty fees and deeper debt. Most reputable lenders do not offer balloon payments because of the level of risk involved.

Prepayment penalties aren’t as detrimental as balloon payments, but they do penalize borrowers for trying to save on interest by paying off their loans early. Some lenders try to recoup this interest by charging fees for early payoff. You can avoid these fees by choosing a lender who doesn’t charge prepayment penalties.

Lenders may adjust your term

Along with the payment schedule, check the amount you’ll pay on each repayment installment. “Is the payment what you expected? If it’s higher, check the loan term,” Ceizyk advises. “The lender may have adjusted the payoff period based on a final review of your income or other debt.”

You can try to renegotiate if an adjusted term doesn’t work for you. You’ll have better luck getting the term you want if you have good credit or can offer collateral. If you don’t have good credit, consider applying for a bad credit personal loan.

2. Know the fees and amounts you’re paying

Fees can substantially increase the cost of a loan — and the cost of fees can vary widely between lenders. “The second thing I’d scroll down to after confirming the monthly payment is affordable is the fees,” Ceizyk says. “These will directly affect how much cash you net from the money you borrow. Since they can range from 0 percent to 12 percent, it’s worth it to shop around if you’re quoted fees in the double digits.”

Standard origination fees for personal loans are paid from the principal of the loan. So if you borrow $5,000 and your origination fee is 10 percent, you’ll receive $4,500. Keep this in mind when deciding how much money to borrow. If you need $5,000, then you’ll actually need to borrow $5,550.

Many borrowers would struggle to pay origination fees upfront. Rolling this cost into their loan makes it easier for people to borrow the money they need — but it also means those borrowers will be paying interest on fees. Over the life of a loan, this additional interest could add up to hundreds of extra dollars.

Loans without origination fees may not be cheaper

Some lenders offer personal loans without origination fees, but these loans may or may not save you money. Along with interest, fees help lenders make a profit. Lenders may inflate other fees to cover what they lose by cutting the origination fee, resulting in similar or higher overall loan costs.

The only way to know if a personal loan without origination fees is cost-effective is to use a personal loan calculator to determine the overall cost of the loan. Research rates on personal loans from different lenders and compare APRs for the most accurate comparison.

Compare the interest and APR

The annual percentage rate (APR) on your loan will be higher than the interest rate. That’s because interest is only the fee you pay to borrow money. The APR reflects the total cost of your loan for a year, including both interest and additional fees.

However, there shouldn’t be a big difference. Ceizyk encourages borrowers to compare the two. “Is the APR significantly higher than the interest rate? If it is, pay close attention to how much the fees are,” he advises.

Fee type and cost vary by lender. For example, many lenders charge an origination fee to underwrite your loan, while others don’t. Other factors affect the fees on your loan as well, such as:

• Your credit score
• Your total income
• Your assets
• Your liabilities
• The purpose of your loan
• The amount you’re borrowing

3. Don’t sign anything you don’t understand

Personal loan agreements are binding, so it’s normal (and wise) to want clarification about their provisions. Trustworthy lenders will be willing to explain clauses you have questions about.

Conditions of default

One section to ask about is conditions of default, which outline what happens if you cannot repay your loan. “Once you know the payments and costs, take some time to review the default provisions,” Ceizyk advises. “This will give you an idea of what the lender has the right to do if you can’t repay the loan.”

Your loan agreement should specify when your loan is in default (usually between 30 to 90 days), what fees will be imposed, how much those fees will cost and what additional actions your lender will take. “It’s especially important reading if you have a secured loan because it could tell you how much time you have before the lender repossesses your car or forecloses on your home,” Ceizyk says.

In addition to seizing collateral, lenders may garnish wages. Some lenders will sell defaulted debt to third-party debt collectors who will try to collect from you. This ends your relationship with your original lender.

Mandatory arbitration clauses

Another important section to look out for is mandatory arbitration clauses. These clauses require you to settle any disputes with your lender through an arbitrator instead of going to court. Signing an arbitration clause could mean waiving your right to:

• Sue your lender
• Appeal the arbitrator’s decision
• Join class action lawsuits
• Help choose an arbitrator

Ceizyk offers this advice to borrowers regarding arbitration clauses: “Don’t sign anything you don’t understand. If you can’t get an explanation you understand, it’s best to move on to a lender offering products you understand. Never sign anything under duress or pressure. High-pressure sales tactics are a sign of predatory lending.”

Credible lenders want their customers to understand all terms and conditions of their loans, and they won’t be surprised if you need them to explain themselves. They work with many customers just like you who also come with questions.

Bottom Line

Personal loan agreements can be intimidating, but knowing what to watch out for makes it easier to work through them. Look for standard repayment plans with fixed rates and monthly payments. Review the fees you’ll pay and how much they’ll increase the overall cost of your loan. Most importantly, ask for clarification on tricky clauses you find confusing before signing on the dotted line.