How to read a personal loan agreement

If you are approved for a personal loan, you’ll receive a loan agreement: A legally binding contract that outlines the terms of your borrowing arrangement. While these documents can seem dense and filled with legal jargon, understanding what you’re signing is crucial.

The good news is that once you know what to look for, reading a personal loan agreement becomes much less intimidating. Here’s everything you need to understand before you sign on the dotted line.

Personal loan contracts are comprehensive documents that outline every aspect of your relationship with the lender. While the specific format may vary between lenders, your agreement should contain the following core elements.

This includes the principal amount you’re borrowing, your interest rate, and the loan term (how long you have to make payments). Most personal loans have fixed interest rates, meaning your interest rate and monthly payments remain constant throughout the life of the loan. This predictability makes budgeting easier.

You’ll also see the annual percentage rate (APR) listed prominently. The APR is often higher than your interest rate because it includes both the interest charges and applicable fees, providing a more comprehensive view of your loan’s true cost. If there’s a significant gap between your interest rate and APR, that’s a sign your loan comes with substantial fees.

This section tells you exactly what you’ll owe each month. Your agreement specifies the monthly payment amount, due date, total number of payments, and payment options. It will also outline what happens if you miss a payment — typically, you’ll face late fees and potential damage to your credit score.

Read more: 5 strategies to pay off your loan faster

Fees and charges

Added fees can significantly increase the cost of your loan. Common fees include origination fees (which may range from 1% to 10% of the loan amount), late payment fees, and insufficient funds fees if a payment bounces.

Origination fees are usually deducted from your loan proceeds, so if you borrow $5,000 with a 10% origination fee, you’ll only receive $4,500 in cash — but you’ll owe interest on the full $5,000.

In rare cases, lenders may also include prepayment penalties, which charge you for paying off your loan early. While this might seem counterintuitive, some lenders use these fees to recoup interest they’d lose from early repayment.

Most personal loans are unsecured, meaning they don’t require collateral. However, some lenders may require you to use a vehicle, savings account, or other asset to secure your loan amount. If collateral is a factor in your loan, it will be outlined in your agreement.

This section covers the rules governing your loan relationship. This may include a mandatory arbitration clause (which requires disputes to be settled outside of court), credit reporting authorization, and the laws that govern your agreement. These sections are often written in complex legal language, but they’re critically important to understand.

Not all parts of your loan agreement carry equal weight. Some sections deserve extra scrutiny because they’ll significantly impact your finances.

• Payment schedule: Start by confirming that your payment schedule matches your expectations. Check whether your lender adjusted your loan term from what you originally discussed. If your monthly payment is higher than expected, the lender may have shortened the repayment period based on a final review of your finances. You can try to renegotiate if this doesn’t work for your budget.

• Fees: Fees can dramatically increase what you’ll actually pay for your loan. After confirming your monthly payment is affordable, check the fee section. These charges directly affect how much cash you’ll actually receive from your loan and the overall cost.

• Delinquency and default terms: Understanding what happens if you can’t make payments is uncomfortable but necessary. Your agreement should clearly specify when your loan is considered in default and which actions the lender may take at that time.

• Dispute resolution: Mandatory arbitration clauses require you to resolve any disputes with your lender through an arbitrator rather than the court system. By signing these clauses, you may waive your right to sue your lender, appeal an arbitrator’s decision, or join class action lawsuits. While arbitration isn’t inherently problematic, it’s important to understand the rights you’re giving up.

Related: How to compare personal loan offers: 7 crucial factors besides interest rates

It’s easy to overlook key details when you’re eager to access funds, but a personal loan agreement deserves careful attention. Avoid these common errors:

• Signing without reading the full contract: Important terms about cost, fees, and obligations may be buried in sections you’d otherwise miss.

• Assuming verbal promises override written terms: Only what’s in the signed agreement is legally enforceable, even if a lender representative said something different.

• Skipping sections that describe penalties: Missing these terms can leave you unprepared for late fees, collections, or other consequences.

• Not checking for red flags: Watch for warning signs such as pressure to sign quickly, balloon payments, unclear fee disclosures, unusually high APRs, or lenders who avoid providing written terms.

Never sign a loan agreement you don’t fully understand. Ask your lender to explain anything that’s unclear, including the meaning of specific legal terms in plain language. Also, be sure to ask about your options if you encounter financial difficulties and how the loan will be reported to credit bureaus.

If you’re not satisfied with the loan offer you’ve received, don’t assume the terms are set in stone. While not everything is negotiable, many lenders have flexibility on certain aspects of the agreement, especially if you’re a strong applicant.

• Show competing offers: Presenting lower rates or better terms from other lenders gives you concrete leverage to request matching conditions.

• Highlight your creditworthiness: If you have a strong credit score, stable income, or low debt-to-income ratio, emphasize these factors to potentially secure a lower interest rate.

• Consider offering collateral: Turning an unsecured loan into a secured one by pledging assets can sometimes result in better rates and terms.

• Negotiate the loan term: Extending or shortening your repayment period can adjust your monthly payment to better fit your budget, though this also affects total interest paid.

• Ask about relationship discounts: If you have existing accounts with the lender, ask about rate reductions or fee waivers for customer loyalty.

• Add a co-signer or joint applicant: Including someone with strong credit on your application can help you qualify for lower interest rates and better terms, as lenders view the loan as less risky.

Signing a loan agreement is a serious financial commitment. Though personal loan agreements can be intimidating, they don’t have to be complicated or mysterious.

Taking the time to read and understand every provision isn’t just smart — it’s essential for protecting your financial well-being. Reputable lenders expect questions and welcome informed borrowers. If a lender makes you feel rushed or uncomfortable, that could be reason enough to keep shopping for a better option.

When in doubt, trust your instincts. If something doesn’t feel right or you can’t get clear answers to your questions, it’s always better to walk away than to sign an agreement you don’t fully understand.

This article was edited by Alicia Hahn.