Agribusiness Loans: Legal Issues, Terms, and Interest Rates

Chapter 2

Promissory Note

Promissory Note -- written evidence of a debt. It is the loan document that creates a contract between the parties.

Elements of a Note

Names of borrower and lender A promise to pay a specific

amount The due date Manner of payment The interest rate

CollateralPenalties for lat or nonpaymentWhether it can be prepaidDates of creation of the instrumentSignature of borrower

Elements of a Note

Parties to Loan Transactions

The parties in a loan transaction include the borrower, lender, and sometimes a third party. Third parties assist in the transaction.

Borrower

Borrower – becomes the debtor and must make repayment under the terms of the loan. They are the maker of the note.

Lender

Lender – provides the initial funds to the borrower and can be a private party, commercial bank or other depository institution, a government sponsored agency or other business. They are known as the beneficiary of the note, they receive the benefit of the interest and principal payments.

Third Parties

Third Parties – include escrow companies, dealers and vendors who provide personal property to the borrower, possible asset recovery entities, such as the local court system.

Security Agreement

A security agreement is a standardized description of the assets pledged as collateral for the loan.

The collateral is classified by type of asset: Inventory Equipment Real Estate

Mortgages Versus Deeds of Trust

Mortgage Document – a pledge of the real estate to the lender as security for the debt

Deed of Trust – provides temporary title to the collateral to an independent third party, usually a title or escrow company. Only comes into effect should the borrower fail to comply with the terms of the promissory note. This is called default.

Other Loan Terminology

Principal – the amount originally borrowed or owed to the lender.

Interest – the “rent” charged by the lender for the use of principal.

Loan Term – the length of time until the loan contract matures. Short term – loans up to one year Intermediate term – loans from one year to ten Long term – loans longer than ten years Term debt – any loan with a term of more than

one year

Amortization

Amortization – the periodic payment of the principal to extinguish the debt over the loan’s term.

Most agribusiness loans are fully amortizing, the periodic payments are sufficient to extinguish the debt over the term or the loan.

Partially amortizing loans have a balloon or lump sum payment at the end.

More common types of loans than partially amortizing loans are interest only.

APR

Annual Percentage Rate or APR - the actual or effective rate of interest for the loan

Points

Prepaid Interest is known as Points One point is 1% of the loan principal Points do not reduce the amount of

interest you pay over the loan’s term They merely enhance the yield by the

lender.

Amortization Schedule

An amortization schedule is an algorithmic table that details the repayment of the loan principal and the payment of interest for the entire term of the loan.

Life Cycle of a Loan

There are seven phases to the loan process

Application – the building of a loan file, provides information for the decision maker on whether or not to grant the loan. Materials they require are employment history, tax returns, insurance, and property holdings and indebtedness

Processing – the loan file is organized to facilitate underwriting

Underwriting – the loan file is scrutinized so that a determination can be made to either approve, deny or suspend the request.

Life Cycle of a Loan

Documents – Preparation of contractual documents. A security agreement for the loan collateral, or mortgage must be prepared. Truth in lending documents. Could be as much as 10 pages for a short term loan and 30 for a real-estate mortgages

Funding - review for legal compliance, if funding goes into escrow the funds will not be released until all contractual obligations are met.

Life Cycle of a Loan

Closing – The formal release of funds to the appropriate party occurs at closing. For property this occurs after deed transfer. Vehicles when legal title is provided to lender

Servicing – performed by the original lender. More sophisticated today.

Default and Foreclosure

Determinants of Interest Rates