What Is a Credit Agreement? Definition, How It Works, Example

What Is a Credit Agreement?

A credit agreement is a legally-binding contract documenting the terms of a loan agreement; it is made between a person or party borrowing money and a lender. The credit agreement outlines all of the terms associated with the loan. Credits agreements are created for both retail and institutional loans. Credit agreements are often required before the borrower can use the funds provided by the lender.

How Credit Agreements Work

Retail customer credit agreements will vary by the type of credit being issued to the customer. Customers can apply for credit cards, personal loans, mortgage loans, and revolving credit accounts. Each type of credit product has its own industry credit agreement standards. In many cases, the terms of a credit agreement for a retail lending product will be provided to the borrower in their credit application. Therefore, the credit application can also serve as the credit agreement.

Lenders provide full disclosure of all of the loan’s terms in a credit agreement. Important lending terms included in the credit agreement include the annual interest rate, how the interest is applied to outstanding balances, any fees associated with the account, the duration of the loan, the payment terms, and any consequences for late payments.

Revolving credit accounts typically have a more simplified application and credit agreement process than non-revolving loans. Non-revolving loans–such as personal loans and mortgage loans–often require a more extensive credit application. These types of loans typically have a more formal credit agreement process. This process may require the credit agreement to be signed and agreed upon by both the lender and the customer in the final phase of the transaction process; the contract is considered effectual only after both parties have signed it.

Institutional credit deals also include both revolving and non-revolving credit options. However, they are much more complicated than retail agreements. They may also include the issuance of bonds or a loan syndicate, which is when multiple lenders invest in a structured lending product.

Institutional credit agreements typically involve a lead underwriter. The underwriter negotiates all of the terms of the lending deal. Deal terms will include the interest rate, payment terms, length of credit, and any penalties for late payments. Underwriters also facilitate the involvement of multiple parties on the loan, as well as any structured tranches which may individually have their own terms.

Institutional credit agreements must be agreed to and signed by all parties involved. In many cases, these credit agreements must also be filed with and approved by the Securities and Exchange Commission (SEC).

Example of a Credit Agreement

Sarah takes out a car loan for $45,000 with her local bank. She agrees to a 60-month loan term at an interest rate of 5.27%. The credit agreement says that she must pay $855 on the 15th of every month for the next five years. The credit agreement says that Sarah will pay $6,287 in interest over the life of her loan, and it also lists all the other fees pertaining to the loan (as well as the consequences of a breach of the credit agreement on the part of the borrower).

After Sarah has read the credit agreement thoroughly, she agrees to all the terms outlined in the agreement by signing it. The lender also signs the credit agreement; after the signing of the agreement by both parties, it becomes legally binding.