Understanding Loan Agreements: Key Insights for Real Estate Transactions

INA&Associates has received numerous consultations on loan agreements through real estate transactions. This is an important topic especially in situations such as financing at the time of real estate purchase and exchanging security deposits and guarantees in rental management, so let's deepen your understanding from the basics.

1. basic understanding of loan agreements

1-1. what is a loan agreement?

A money loan contract is a form of contract stipulated in Article 587 of the Civil Code in which one party (borrower) receives money from the other party (lender) and promises to return the same type, amount, and kind of money. Simply put, it is a contract that stipulates a promise to lend or borrow money.

(Loan for Consumption) 
Article 587 A loan for consumption shall become effective when one party receives money or other things from the other party with a promise to return the same kind, quality and quantity of things. 

This contract is also very important in real estate transactions. For example, a mortgage contract at the time of real estate purchase is a loan contract between a financial institution (lender) and a purchaser (borrower). Also, the handling of security deposits and guarantees received from tenants in apartment management and the like also involves the concept of a loan for consumption contract.

1-2. April 2020 Amendment to the Civil Code and Its Impact

The revision of the Civil Code that came into effect on April 1, 2020 resulted in important changes regarding money loan contracts. Before the amendment, it was considered to be a "contract of essentials" and to be effective only when money is given or received. After the amendment, however, it is considered to be a "contract of consent" and to be effective only by agreement of the parties if it is in writing or recorded in electromagnetic form.

(Reservation of loan for consumption) 
Article 587-2 A reservation of loan for consumption shall not be effective unless it is made in writing. 
2 If a reservation of loan for consumption is made by means of an electromagnetic record recording the contents thereof, such reservation of loan for consumption shall be deemed to have been made in writing and the preceding paragraph shall apply. 

This is a major change in practice. Previously, the assumption was that "no contract has been formed at the stage prior to the actual delivery of money," but now the situation is such that "a contract is formed only by written agreement. In real estate financing as well, the parties to the contract must be careful because legal rights and obligations arise from the stage prior to the actual execution of the loan.

2. components of a loan agreement

2-1. Main Clauses Required in the Contract

A loan agreement typically includes the following clauses

1. Borrowing and lending of money: specifying the amount of the loan, the date of the loan, and the method of delivery
2. Clauses regarding repayment: repayment date, repayment method (lump sum or installments, payee, etc.)
3. Clauses concerning interest: interest rate, method of calculation, time of payment
4. Late payment penalties: additional rate for late payment, calculation method
5. Forfeiture of benefit of time clause: stipulates that the borrower loses the right to make installment payments if the borrower does not fulfill the obligation, etc.
6. Clauses on collateral and guarantees: Provisions regarding the establishment of collateral and guarantors, if necessary
7. Clause on contract cancellation: Conditions under which the contract can be cancelled
8. Agreed Jurisdiction Clause: designates the court in the event of a dispute

In the case of real estate financing, clauses that create a mortgage on the property and clauses regarding property management obligations are also important, etc. In INA & Associates' experience, loss of benefit clause is particularly important to prevent problems later on, so we recommend that you specifically and clearly specify such clauses.

2-2. importance of the forfeiture of the benefit of time clause

A forfeiture of the benefit of time clause is a clause that states that if a borrower falls under certain circumstances, he or she loses the benefit of time for installment payments, etc., and must pay the remaining debt in a lump sum. Without this clause, for example, if the borrower fails to make monthly payments, the lender can only demand payment for each installment and cannot demand lump-sum repayment of the remaining balance.

Common grounds for forfeiture of the benefit of time include the following

• Late repayment (e.g., two consecutive missed payments)
• Significant decrease in the value of the collateral
• Filing for bankruptcy or civil rehabilitation proceedings
• Compulsory execution or foreclosure
• If a false declaration is made
• In the event of breach of contractual obligations

In real estate transactions, change of use of the building, unauthorized transfer, breach of management obligations, etc. may also be stipulated as grounds for forfeiture of the benefit of time, and in INA&Associates' experience, having these provisions firmly in place will ensure smooth resolution in the event of any problems.

3. practical considerations and measures

3-1. interest and the Interest Rate Restriction Law

The setting of interest in a loan agreement must comply with the maximum interest rate under the Interest Rate Restriction Law. Under the Interest Rate Restriction Law, the maximum interest rate varies depending on the amount of the principal:

• Principal amount less than 100,000 yen: 20% per year
• Principal of 100,000 yen or more but less than 1,000,000 yen: 18% per year
• Principal of 1,000,000 yen or more: 15% per year

The interest portion exceeding these maximums will be invalid, so care must be taken when drafting the contract. In addition, if a business is engaged in the money lending business, it must also comply with the Money Lending Business Act and other related laws and regulations. The recipient of a loan from a real estate investment can protect himself/herself from unfair contracts by understanding these maximum interest rates.

3-2. validity of electronic loan agreements

With the advancement of technology, more and more loan agreements are being concluded electronically. INA&Associates is promoting DX in real estate transactions and has realized the following benefits from the introduction of electronic contracts:

1. Reduction of stamp tax (revenue stamps are not required for electronic contracts)
2. Shorter contract signing time
3. Improved storage efficiency and searchability
4. Reduction of environmental impact

However, even in the case of electronic contracts, it is necessary to meet requirements such as identification based on the Electronic Signature Law and measures to prevent tampering. It should also be noted that the contracts must be stored in accordance with the Electronic Bookkeeping Law.

3-3. points of caution for loan agreements between individuals

There are cases where funds are loaned between individuals for real estate investment, etc. Special attention should be paid to loan agreements between individuals. The following points should be noted:

1. Prepare a written contract: Make sure to clarify the contract in writing, not just verbally.
2. Clarify repayment deadlines and methods: Avoid vague promises such as "I can pay you back when I can.
3. Agree on interest: Clarify whether interest is interest-free or interest-bearing, and if interest-bearing, the interest rate.
4. Affixing revenue stamps: Affix revenue stamps in proportion to the contract amount (but not required for electronic contracts).
5. Witness of a third party or witness: If possible, the contract should be signed in the presence of a third party.
6. Consideration of notarization: If the amount is large, consider notarization.

INA&Associates provides appropriate advice based on these points, especially for private loans related to real estate investment. Because of the relationship of trust, it is important to clearly state the details of the contract.

4. actual loan agreements in real estate transactions

4-1. Key Points of Mortgage Contracts

A mortgage contract is one of the most common loan contracts. It is important to understand the contents of the contract and prepare for future risks. In particular, pay attention to the following points:

1. Choice between variable and fixed interest rates: future repayments may vary depending on the interest rate type
2. Conditions for early repayment: Check the fees and conditions for early repayment.
3. Group credit life insurance: Whether or not the mortgage will be repaid in the event of the borrower's death, etc.
4. Collateralization: Details of the mortgage on the property to be purchased
5. Modifiability of repayment terms: Provisions regarding changes in repayment terms, such as in the event of a decrease in income

INA&Associates' clients often ask us for advice on the detailed terms of their mortgage contracts. Especially in recent years, when interest rates have been rising, there has been an increase in the number of consultations regarding switching from floating interest rates to fixed interest rates and the timing of early repayment.

4-2. Characteristics of Loan Agreements for Real Estate Investment

Loans for real estate investment have different characteristics from mortgage loans:

1. Different screening criteria: There are unique screening criteria such as the profitability of the property and the experience of the investor.
2. Interest rate level: Generally, interest rates tend to be higher than those of mortgage loans
3. Loan term: Relatively short term in many cases
4. Recourse/non-recourse loans: Extent of individual investor liability in the event of default
5. Loan-to-value (LTV) ratios: Loan-to-value ratios are limited to the value of the property

INA&Associates informs clients considering real estate investment of the characteristics and precautions of these types of loans, and also provides advice on financial planning with an eye to long-term profitability.

5. loan agreements in the digital age

5-1. use of electronic contracting systems

INA&Associates is actively promoting digital transformation (DX) in real estate transactions, and we are also promoting the use of electronic contract systems for loan agreements. The advantages of electronic contracts include the following

1. Faster conclusion of contracts: No need to send physical documents by mail, significantly shortening the time required to conclude a contract.
2. Cost reduction: Reduction of stamp tax, paper cost, mailing cost, etc.
3. Improved management efficiency: Centralized management of electronic data improves searchability and reduces the risk of loss
4. Improved security: Appropriate electronic signatures reduce the risk of spoofing and tampering.

Especially in real estate transactions, multiple contracts are often required, and we feel that the efficiency gains from the introduction of electronic contracts are very significant.

6. contract drafting to build trust

6-1. importance of easy-to-understand contracts

In a loan agreement, preparing an easy-to-understand contract is more than just a formal requirement. The following points are particularly important

1. Plain language: Avoid using more legal terms than necessary and use expressions that the parties can understand.
2. Structuring clauses: group relevant clauses together and place them in a logical order
3. Emphasize important terms and conditions (interest rates, repayment dates, forfeiture of the benefit of time, etc.).
4. Provide concrete examples: Avoid abstract expressions and use concrete examples.

6-2. points for checking the contract

The following are points to check when checking a loan agreement:

1. Notation of parties: Are there any errors in names, addresses, etc.?
2. Notation of the amount: Are there any errors in the loan amount (in particular, consistency between Chinese numerals and arithmetic numbers)?
3. Repayment terms: Are the repayment date and method clear?
4. Interest calculation: Is the interest rate, calculation method, and payment period clear?
5. Reasons for forfeiture of benefit of time: In what cases is lump-sum repayment required?
6. Collateral/Guarantee Terms: Are the scope of collateral and the guarantor's liability clear?
7. Termination conditions: In what cases can the contract be terminated?
8. Covenants: If there are any special agreements, are they clearly stated?

Conclusion: Knowledge of loan contracts useful in practice

Loan contracts are a very important form of contract in the transaction society. Especially in real estate transactions, they are used in many situations such as mortgage contracts and investment loans. Proper understanding and appropriate use of this contract can greatly contribute to the smooth progress of business and the building of relationships of trust.