How to Read a Personal Loan Agreement and Its Fees

A handshake may seal the deal when borrowing a few bucks from your buddy, but you'll need something a bit more formal to take out a loan with a traditional lender.

That's the role of a personal loan agreement, a small yet powerful document that ensures your promise to repay a debt is as good as gold.

What Is a Personal Loan Agreement and Why Is It Important?

A personal loan agreement is a written contract that you sign when borrowing money from a credit union, bank, online lender, and in some cases, from a friend or family member. It serves as your promise to repay the personal loan and helps to protect both you and the lender if there's a disagreement or dispute.

What Do You Look For in a Personal Loan Agreement?

Personal loan agreements contain important information about you and the lender, as well as details related to repaying the loan. Key elements include:  

Loan Amount

The sum of money you're borrowing from the lender. Limits for personal loans generally range from $1,000 to $100,000.

Interest Rate

The rate used to determine the amount of interest you must pay the lender to borrow money. Personal loan rates are calculated as a percentage of the loan amount using an annual percentage rate (APR).

Repayment Term

The length of time you have to pay back the loan, plus interest. Terms for personal loans range from 1-10 years, and payments are typically made in monthly installments.

Fees and Penalties

Costs the lender may charge as a condition of the loan or if certain aspects of the agreement are broken or not honored. Loan fees and penalties can include origination fees, prepayment penalties, late fees, application costs, and other charges.

Since personal loan agreements differ among lenders, your contract may include more information than these key components. For example, if you're taking out a secured personal loan, the agreement will list the collateral you're using to guarantee the loan and explain what could happen to the asset if you default.

Personal Loan Fees

In addition to standard terms and conditions, the loan agreement will outline required and optional fees you may have to pay.

What Is a Personal Loan Origination Fee?

A personal loan origination fee is a one-time, up-front charge your lender may assess to process and underwrite your loan and pay out the funds. Origination fees commonly range from 1-6% — sometimes up to 10% — of the loan, depending on such factors as your credit score, repayment term, amount you're borrowing, and income.

Not all lenders charge origination fees. Those who do usually deduct the amount from loan proceeds. For instance, if you were borrowing $5,000 with a 1% origination fee ($50), you'd receive $4,950 in net funds.

What Is a Prepayment Penalty?

A prepayment penalty is an optional fee that some lenders impose if you pay off part or all of your loan before the term ends. Fees for early repayment are usually 2-5% of the original loan amount.

Although it may seem counterintuitive to be penalized for paying back your loan ahead of schedule, it makes sense from the lender's perspective.

Lenders make their money on monthly interest charges, so if you reduce the number of payments they receive, you're effectively cutting their profit. Prepayment penalties help the lender recoup some or all of the interest charges they'd otherwise lose if you pay your loan off early.

What Is an Application Fee?

Not to be confused with an origination fee, an application fee is a small, up-front cost (usually $25-50) some lenders charge to review your personal loan application. These fees are uncommon — or, perhaps more appropriately, unnecessary — so if a potential lender wants you to pay one, you should ask for it to be waived or search for another loan partner.  

What Is a Late Payment Fee?

A late payment fee is exactly what the name implies: a fine for failing to pay your monthly bill by the date specified in your loan agreement. Some lenders tack on a flat rate of $25-50 for late payments, while others charge 3-5% of the monthly payment amount.

If you incur a late payment fee, it should appear on the following month's statement. You can appeal the charge if there's a good reason your payment was delinquent, but there's no guarantee the lender will remove it. Either way, being consistently late with your payments will damage your credit score, which can impact your ability to borrow money in the future.

What Is a Non-Sufficient Funds Fee?

Commonly known as a returned check fee, a non-sufficient funds (NSF) fee is a penalty most lenders assess when you try to pay your bill using an account that doesn't have enough cash in it to cover the entire payment. NSF fees, which typically range from $20-50, help your lender cover the costs of processing a check (or electronic payment) that wasn't valid.

For instance, if you write a $550 check for your monthly loan payment and only have $450 in your account, the check will "bounce." Since the lender won't be able to complete the transaction, they'll charge an NSF fee — on top of any penalties your credit union or bank may impose — for their time and inconvenience. Chances are good your lender will also assess a late payment penalty because they didn't receive your payment by the due date.

How to Avoid Personal Loan Agreement Fees

The best way to avoid paying personal loan fees is to look for a lender that doesn't charge them. Although you probably won't find a creditor who waives penalties for late payments and insufficient funds, most other fees are negotiable. Some lenders even specialize in no-fee loans.

Keep in mind that interest rates may be higher on low- or no-fee products. On the other hand, lenders that offer lower interest rates may charge more fees to make up the difference.

When weighing your options, ask potential lenders for a full schedule of fees and the exact amounts of each charge. This information, combined with the APR of each loan, will allow you to calculate monthly loan payments and compare alternatives more accurately. 

The Takeaway

At the end of the day, personal loan agreements — and the fees that often come with them — are legally binding arrangements that can impact your financial well-being for years to come.

So, before you put pen to paper, make time to understand exactly what you're signing and why.

It's the first step to fulfilling your future obligations and proving your pledge is more than words.