Private money lending contracts can seem complicated. They are, in fact, an amalgamation of many legal aspects, including tax law, accounting law, and audit standards for financial reports on private entities. Contracts signed between lenders and borrowers should be well-drafted to adequately protect the lender’s interests. To ensure protections are upheld in every possible situation for both parties involved with the contract, lenders should always consult an attorney before signing a loan agreement with a borrower who is seeking financing from outside sources for any business endeavor or investment purpose. Here are five important aspects of compliance and protection that a lender and borrower may face when drafting a private money lending contract.:
1). Definition of the term “Lender” for purposes of a private money lending contract
A lender is defined as an entity or person who provides private money lending at any time. The term can be applied to the lender, both in its singular form and in its plural form. It is up to the discretion of a lender as to whether it will operate in the single- or multi-lender format. The same applies to a borrower who will select one or more lenders.
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The lender should always define the term, “Lender,” insofar as it pertains to each entity that will act on behalf of itself and/or on behalf of other entities which may be different from the whole group as a whole. The definition must be thorough and detailed enough to provide the lender with a clear understanding of the entity’s role in relation to other entities that may not be in the direct service of the lender but are still responsible for its interests.
2). Prohibition of “Splitting of Borrower’s Profits”
Lenders must always abide by state and federal laws that regulate lending activities and financial obligations. The prohibition against splitting borrower profits is a frequent source of confusion in contracts signed between borrowers and lenders.
The most important purpose of any private money loan agreement is to protect both parties by clearly defining all terms, responsibilities, obligations, rights and liabilities that will apply to both parties. When a borrower and lender sign an agreement together, both should be aware of the stipulations and expectations in the contract. A borrower should know what steps to take to ensure that their profits are not being split between multiple entities or people. Most lenders want anything leftover after the company pays its expenses to be used for profits or to pay back their loan in full, as agreed upon in the original lending agreement. If a borrower, however, wants any money left over after paying off his initial loan to be split with another entity or person, then this would need to be clearly stated in writing before it occurs.
3). When a Lender may take Over Borrower’s Profits
When a lender stipulates that it may take over the profits made by a borrower, the stipulations need to be clearly-worded, and include details regarding any situations in which this will occur. Sometimes, when profits are split with a third party or entity, the lender may want to make sure it receives as much as its originally expected returns on investment.
4). Fraud – Definition of Fraud and what constitutes fraud when committing fraud
Lenders who provide private money lending services will incur financial losses due to fraud committed by their borrowers. The lender should have clear-cut rules and procedures in place to prevent such occurrences from occurring. When a lender suspects fraud has taken place, this should be clearly defined in writing and addressed immediately. Fraud can take many forms such as: misrepresentation of one’s identity, misrepresentation of a business structure, participation in fraudulent loans or purchase agreements that do not follow state and federal laws.
In an effort to protect their investment, money lenders may require that all loans be guaranteed by an external third party. This may seem beneficial to the borrower because this will ensure that their loan does not default. However, if the guarantee is required by a lender, it will most likely mislead the borrower into believing that they are protected. A guarantee exists to protect a lender’s investment by ensuring that the loan will be repaid. Therefore, the borrower should always ensure that the third party is going to play a role in helping him repay his loan. If they are not, it may mean that their profits are being split between multiple entities or people, which would be a violation of terms in the lending agreement.
5). Contractual Definitions of Loan Amounts and Interest Rates
Lenders must provide borrowers with specific details of amounts borrowed and amounts paid back in interest rates to be compliant with federal law. For example, a lender who has loaned an individual $100,000 is considered to have “loaned” this amount “no matter how long it takes. The lender should not let a borrower reach the end of his loan term and then claim that he has only repaid $40,000 of the original $100,000 borrowed. The purpose of this is to protect a lender from any additional losses that may arise when it is time to collect on a loan. When it comes to interest rates, lenders should define what constitutes an “interest rate” along with how interest payments will be applied and collected in accordance with federal laws.
In summary, both borrowers and lenders should consider the terms outlined above when entering into any private money lending agreement. Both parties should always remember that loans are large amounts of money that people give to others with the understanding that they will be paid back in full. Therefore, both parties must maintain a good faith relationship at all times.