Entry IV · The Library

Reading a loan agreement before you sign

Nobody reads the whole thing. You do not have to. But there are nine places in a consumer credit agreement where the outcomes are decided, and they can be found in about twenty minutes.

Reference entry · Educational content · Not an offer of credit

Section oneBefore you open it

Two ground rules. First, you are entitled to a copy of the agreement to read before you sign it, not at the moment of signing with somebody waiting. Ask for it in advance and take it away. A lender who will not let you read the contract is telling you something useful about the contract.

Second, read with a pen and mark four things as you go: any number, any deadline, any condition that triggers something, and any word you cannot define. The last category is what the glossary is for. Numbers and deadlines are where disputes come from.

Section twoThe Truth in Lending box

Near the front of a closed-end consumer credit agreement there is a boxed table with a small number of figures in it. It is federally prescribed, it is the same on every such agreement, and it is the most information-dense object in the document. It shows the annual percentage rate, the finance charge, the amount financed, and the total of payments, together with the payment schedule.

If any of those four numbers is not what you expected, stop there. The rest of the document will not fix it, and every other clause is downstream of these. The arithmetic behind them is worked through in how loan interest actually works.

Section threeThe promise to pay

The operative clause — often called the promissory note or note section — states what you owe, the rate, the payment amount, the due date and the maturity date. Check the due date against when you are actually paid. A payment falling three days before your salary arrives is a late fee waiting to happen, and the due date is frequently negotiable at origination and almost never afterwards.

If the rate is variable, this section will name the index it is tied to, the margin added to it, how often it adjusts, and any caps on how far it can move per adjustment and over the life of the loan. Find the lifetime cap and read the payment at that rate, not at today's rate. That is the commitment you are making.

Section fourThe fee schedule

Fees are usually listed together, sometimes on a separate page, and they are worth a careful minute. Look for: origination or administration fees; late fees and the grace period before one applies; returned payment fees; payment convenience fees for paying by card or phone; documentation, title or filing fees on secured loans; and on some products, a fee to obtain a payoff statement.

The number that matters most is the grace period, because it is the one you will actually use. A five-day grace and a fifteen-day grace are materially different products for anyone whose income arrives irregularly.

Section fivePrepayment

Find out what happens if you pay early, and get it in one of three categories. Some agreements allow prepayment freely with no charge. Some impose a prepayment penalty, often on a declining schedule over the first years. Some are precomputed, so the finance charge was calculated at the outset and early payoff does not automatically save the unearned interest unless a rebate applies.

Also check how additional payments are applied. If you send extra money, does it reduce principal, or is it held and applied as the next instalment? Those two outcomes differ enormously over a long loan, and the difference is usually a single sentence in this section.

Section sixDefault and acceleration

Two clauses, read together, describe the worst case.

The default clause defines what counts as default. It is nearly always broader than “you missed a payment.” It commonly includes failing to maintain required insurance on collateral, providing false information on the application, filing for bankruptcy, selling the collateral, or a cross-default triggered by defaulting on another obligation to the same lender.

The acceleration clause says what the lender may do about it: declare the entire remaining balance immediately due, rather than pursuing the missed instalment. Acceleration is what turns a missed payment into a demand for the whole loan, and on a secured loan it is the step that precedes repossession or foreclosure. Read what notice and what cure period, if any, you are entitled to first.

Section sevenSecurity and insurance

On a secured loan there will be a security agreement describing exactly what is pledged. Read it for scope. Language securing “all present and future obligations” to the lender means the asset backs more than the loan you are signing for — see secured and unsecured loans explained.

You may also be offered optional add-ons: credit life, disability, involuntary unemployment cover, or guaranteed asset protection. These are products with their own price and their own terms, and buying them is separate from getting the loan. If a document suggests otherwise, that is a question to ask out loud before signing.

Section eightDispute resolution

Toward the back you will usually find an arbitration clause, sometimes with a class-action waiver, and a governing-law provision naming the state whose law applies. Occasionally there is a time-limited right to opt out of arbitration by writing to a specified address within a set number of days of signing. If that opt-out exists, it is described in this section and nowhere else, and the window is short.

Section nineAssignment and servicing

Nearly every agreement permits the lender to sell or transfer the loan. In practice this means the company you make payments to may change, possibly more than once. Your terms do not change when that happens, but your payment address, portal, and customer service quality all can. Keep your original agreement, your amortisation schedule and your payment records; if a transfer goes badly, those documents are your evidence.

Section tenA twenty-minute checklist

1. Read the four figures in the Truth in Lending box, and check the APR against your quote.
2. Divide the total of payments by the amount financed.
3. Confirm the payment due date works with when you are paid.
4. If the rate is variable, find the lifetime cap and price the payment at that rate.
5. Find the grace period and the late fee.
6. Establish the prepayment position and how extra payments are applied.
7. Read the default definition in full — all of it, not the first clause.
8. Read the acceleration clause and any cure period.
9. On secured loans, check the scope of the security and the insurance requirements.
10. Check for an arbitration opt-out and diarise the deadline if there is one.

If something is wrong, the moment before signature is the only moment you have leverage. After signature you are asking a favour; before it you are negotiating a deal.