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Loan Agreement

An obligation contract by which a lender makes money or fungible goods temporarily available to a borrower for use for an agreed period is called a loan agreement. During this period termination is possible, but it becomes irrelevant after the term expires. Fungible goods are items of equivalent procurement that are interchangeable with one another.

At the due date, i.e. after the loan term has expired, the borrower is obliged to return the nominal amount equal to the loan or to return equivalent goods. Returning equivalent goods, in the case of a monetary loan, means repaying the loan amount plus the interest that both contracting parties agreed upon before the term began. Upon conclusion of the contract, the borrower receives the loan object, in this example the agreed loan amount, for unrestricted use.

If a loan is granted for consideration, the borrower must pay interest in addition to the loan amount. The terms "loan" and "credit" are mostly used synonymously.

Legal regulations for loan agreements

In 2002 German law on obligations was modernised. In the process, the loan agreement acquired the legal character of a mutual consensual contract, providing more legal security, whereas previous legal provisions regarded the loan agreement as a real contract.

As part of the statutory reform, the monetary loan described in §§ 488 ff. BGB is now distinguished from the goods loan laid down in § 607 BGB.

Key characteristics of a loan agreement

To create a loan agreement, there must be a meeting of minds between the two contracting parties, the lender and the borrower, on the essential elements of the loan. These include determining the loan amount or the quantity of goods to be lent and the agreement on the interest rate.

For a monetary loan, the interest rate determines the sum that the borrower typically has to pay after one year for the use of the money made available to them. For a loan term of less than one year, the interest becomes due upon repayment of the loan (§ 488 II BGB).

Only fungible, i.e. replaceable, items can be the subject of a goods loan. Unlike a lease or rental agreement, the borrower of a goods loan becomes the owner of the loan object and may therefore sell or consume the item.

When a goods loan falls due, the borrower is obliged to return fungible items of the same kind and quality to the lender.

Provisions in a loan agreement

A loan agreement constitutes a continuing obligation relationship and does not involve a one-time exchange of performance and consideration (as is the case, for example, with a purchase agreement). Rather, the contractual relationship extends over a certain period during which specific recurring performances or certain conduct are required.

For an interest-free loan commonly given among relatives, for example, this is not a mutual contract but only a so-called bilaterally obligating contract, since the mere obligation to repay does not constitute consideration for receiving the loan. Only the agreement of an interest rate results in a mutual contract.

If no due date is specified in the loan agreement, repayment of the loan is effected by termination with three months' notice. If a fixed loan term is agreed, termination is only possible in certain cases that are legally regulated or contractually agreed. There is also the possibility of mutually rescinding the loan agreement.

A loan agreement is void pursuant to § 138 BGB if it fulfils the offence of usury. For this, performance and counter-performance must be extremely unbalanced. "Interest usury" is spoken of when the interest rate specified in the loan agreement exceeds twice the level of the usual market interest rate.

Different types of loans in a loan agreement

With a so-called bullet loan (end-of-term loan), repayment is made in a single amount at the end of the term. A

Annuity loan features a consistently equal instalment amount composed of interest and principal repayment.
As the loan is gradually reduced by the instalment payments, the repayment portion continuously increases while the interest burden decreases. In contrast, instalments are reduced in a constant-amortisation loan because the principal repayment remains constant while the interest portion decreases.
In a so-called term loan, interest on the loan amount is added at the beginning of the loan term according to the agreement. The resulting total amount is then repaid in equal instalments.
An call loan is a possible loan form in consumer lending by banks, where a credit line that can be drawn on at any time is made available and, unlike an overdraft facility, is repaid in fixed instalments.
Rolling money market loans ("roll-over loans") are medium- to long-term loans. At the end of each of the short interest-fixing periods provided for this credit form, repayment can be made flexibly. The interest rate for these loans is oriented to the money market.
A building society loan (Bauspardarlehen) is a special form of credit in which, after saving up a portion required for a real estate investment, the outstanding amount is granted as a loan.
A so-called mass loan is taken out by an insolvency administrator to maintain the business operations of an insolvent company.

Loan securities

Within the framework of a loan agreement, loan securities may be agreed. This includes, for example, the transfer of security ownership of goods, whereby ownership of an item is transferred to the lender while the borrower nevertheless continues to have economic use of it.

Assignment of claims (cession) means that a creditor transfers a claim owed to them to another creditor. In a guarantee (surety), the guarantor assumes liability for the obligations of the principal debtor. Land charges (Grundschulden) grant a real right in a property from which the creditor can demand payment.

The costs of the loan

To compare the costs arising from taking out a loan at different credit institutions, the effective interest rate method was developed. When calculating the effective annual interest rate expressed as a percentage of the loan disbursement amount, the nominal interest rate as well as the discount (disagio), the repayment and the interest-fixation period specified in the loan agreement are taken into account.

For creating a comparative calculation, the traditional annuity calculation can also be used, in which the loan disbursement amount is presented in a clear form against the sum of interest, principal repayment, fees and insurance costs.