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

A credit agreement is a legally binding contract between a borrower and a lender that documents all of the terms of a loan. Credits agreements are created for both individual and business loans.

While all credit agreements serve the same basic purpose, they can vary somewhat depending on the type of credit that's involved, such as credit cards, personal loans, mortgages, and lines of credit. They are also governed by a variety of federal and state laws.

In many cases, the terms of a credit agreement will be provided to the borrower as part of their credit application. Therefore, the credit application can also serve as the credit agreement.

Lenders must provide a full disclosure of all of the loan's terms in the credit agreement. That can include the annual interest rate (APR), 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 simpler application and credit agreement process than non-revolving loans. Revolving credit refers to loans with no fixed end date that the borrower can take money from repeatedly, up to a predetermined credit limit. Credit cards are one example, as are lines of credit, including home equity lines of credit (HELOCs).

Non-revolving loans, such as mortgages and auto loans, have a fixed end date and a prescribed repayment schedule. They often involve a more extensive credit application process and a more detailed credit agreement. Part of the reason is that these types of loans tend to be for higher amounts of money, so the lender is putting more at risk.

Non-revolving loans are also more likely to require some form of collateral to back them. With a mortgage, for example, the home typically serves as collateral, while auto loans are typically secured by the vehicle the loan is being used to purchase. This should all be spelled out in the 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 and that she will pay $6,287 in interest over the life of her loan. It also lists all the other fees pertaining to the loan and describes what will happen if she fails to keep up with the payments.

After Sarah and the lender have both signed the agreement, it becomes binding on both parties.

Yes, credit agreements can be negotiated beforehand and sometimes renegotiated later. However, as the American Bar Association points out, "The borrower's most important strategy, by far, is to negotiate critical loan provisions before it signs the commitment, not after.... At the commitment stage, the borrower may actually or purportedly be negotiating with other lenders. This is the moment when the loan officer will be the most flexible in order to get the loan in the door."

Lenders are sometimes open to renegotiating an existing credit agreement if it is their financial interest to do so. For example, a homeowner with a mortgage may be able to renegotiate the terms of their loan if they face a financial hardship that makes it impossible for them to keep up with the original payment schedule. Rather than foreclosing on the home (which can be costly and time-consuming for lenders), the lender might agree to a pause in payments, lower monthly payments stretched over a longer period of time, a reduced interest rate, or some other concession. This is often referred to as a mortgage loan modification.

Businesses can have similar leverage with their lenders. "Banks are open to renegotiating loans especially when the alternative is that your business is unable to repay a loan and facing bankruptcy," the U.S. Chamber of Commerce notes.

Yes, and they often do, if the original agreement has provisions allowing for that. If the changes are "significant," the Consumer Financial Protection Bureau (CFPB) says, the card issuer must generally give you 45 days advance notice.

What constitutes a significant change? According to the CFPB, those might include "increases in certain interest rates and fees, increases to the minimum amount due, or changes to the grace period or the way interest is calculated." The card issuer is generally not allowed to raise the interest rate on your existing balances, except in a few specific circumstances.

As the CFPB points out, you have a right to opt out of the changes. "However," it adds, "if you opt out, the card company might close your account."

Once you've signed the mortgage note at the closing, it is binding on you and the lender. If the lender sells your loan to another lender or investor, as is often the case, those terms still remain in effect. One thing that can change is your interest rate and monthly mortgage payment if you've signed up for an adjustable- or variable-rate mortgage rather than a fixed-rate one. However, those changes are subject to rate caps that should be spelled out in your mortgage agreement.

Credit agreements are important documents, binding on both the borrower and lender. As a borrower, you may have some leverage in negotiating more favorable terms than the lender offers you initially, but it's best to work that out before signing rather than trying to renegotiate the agreement later.