Borrowing and borrowing money is something most of us do at some point in our lives. Whether it’s a formal loan with a bank or between friends or relatives, recording the loan helps ensure that the entire lender is eventually repaid.
A verbal agreement is not enough if large sums of money are exchanged informally, such as when you lend your brother money for a car or when you help a friend with rent. Conversely, a legal document such as a promissory note can hold both parties accountable for their roles in the agreement.
What is a promissory note?
A promissory note is a legally binding contract where one party promises to pay another party a specified amount of money, either on a recurring basis or in full, by a specified date. The note contains all the details about the loan, such as the amount, the interest on the loan, the due date and the payment schedule.
The lender does not have to sign the promissory note, but the borrower does because in the written document they promise to repay the money. Since a promissory note is legally enforceable, it is important that all the details are correct before the borrower signs it.
Even if the loan is between friends or relatives, working with a lawyer is the best course. They use legal document drafting software to ensure that the relevant details are included in the contract and contain the necessary signatures to make the promissory note binding.
When are vouchers used?
Any type of financial lending can use promissory notes, either as stand-alone documents or as part of the paperwork required when borrowing large sums of money for big ticket items. Both personal lending and business transactions use promissory notes to provide the lender with legal protection.
Some of the most common uses of letters are:
- Real estate. As part of the home or business investment mortgage documents, the buyer signs promissory notes to indicate their obligation to repay the money they used for the property.
- Student loans. When someone takes out a higher education loan, they fill out promissory notes to repay those funds. Federal loans often allow students to sign a basic affidavit, which covers any loans taken out within the next 10 years that the student remains enrolled.
- Business equipment purchase. Any loan that a business takes out to finance necessary operating equipment comes with a promissory note. Like personal loans, these notes state that the business is responsible for repaying the entire amount by a certain date.
- Capital. Some businesses may take out loans to support their operations, particularly in the off-season or when starting a new company. The money acts as funding for basic day-to-day expenses until income can replace it. These loans have their own promissory notes.
Many people choose not to use promissory notes when lending money to friends and family, even for a lot of cash. However, this is a risky move and there is no guarantee that you will see this money again. And without a promissory note, you can’t do anything unless you get paid.
For small quantities, no note is usually required. But for money you’d lose if you didn’t get it back, a promissory note does the trick.
Types of promissory notes
Depending on the type of loan, you need different types of promissory notes to set the repayment terms for the borrower.
Simple
This is the most basic type of promissory note and is generally used for smaller loan amounts with a single borrower. If two people are exchanging money, all they need is a simple note. The details included in a simple promissory note can be removed as much as the amount, repayment terms, payment schedule and the names of the parties involved.
Open
A perpetual note is more like a line of credit than a traditional loan. Borrowers only get a portion of the full amount up front, but can get additional money later if they need more by repaying the original amount borrowed. This can be easier to manage than taking out multiple loans with different notes.
Mr
If a borrower needs multiple loans, he and the lender can use a master promissory note as a running agreement. This can cover multiple loans between the same parties over a given period of time, such as individual student loans.
Secured
A secured note usually carries better interest rates than the other types because something of value must be pledged as part of the loan. If the borrower fails to repay the money, this secured note allows the lender to obtain the collateral in lieu of the remaining payment.
Safe
Unsecured promissory notes do not require the borrower to post any collateral, but there are still legal options for the lender if the borrower defaults on their repayments.
These promissory notes are common in real estate transactions, as the mortgage is used to secure the loan rather than any additional security. If the mortgage is not paid off, a lien can be placed on the property allowing the lender to foreclose and get their money back.
Information contained in a promissory note
The basic elements of a contract should also be included in a promissory note. Additional details may be required depending on the type of note, but at a minimum a promissory note must contain:
- Lender and borrower contact details. Along with the signature date, the first section of a promissory note describes who is borrowing the money and who is lending the money.
- Total loan amount. The lender and borrowers must agree on the total amount of money exchanged.
- Expiration date. Then the bill ends. the full amount must be repaid by this date. Some promissory notes may also state this as the ‘expiry date’.
- Fees, interest details and penalties. The fees associated with creating the note are listed here, along with the interest rate details and any penalties that will be imposed if the borrower defaults on the payment agreement.
- Repayment terms. These provide all the information about exactly how the borrower will repay the money. Most promissory notes for larger amounts are in installments, either weekly, monthly or quarterly. Smaller amounts may be due as a lump sum by a specified date.
- Repayments start date. This date is important for the borrower to know because not all repayments start once the promissory note is signed.
- Applicable law or jurisdiction over the note. Where the promissory note is signed is very important. If the lender needs to take legal action against the borrower, this information describes which geographic area – or governing body – is responsible for overseeing legal proceedings.
- Borrower’s signature. Only the borrower signs the promissory note, as it is his promise to repay the money.
If you are using a secured promissory note, you must include details of the collateral. Master notes also have more complex information about how long the note is good for and the type of loan it covers.
How are promissory notes repaid?
Like a traditional loan agreement, borrowers can repay in a variety of ways. Along with lump sum and installment, you also have pay-as-you-go and balloon payments.
- Debts on demand. If there is no specific payment information listed on a promissory note, the lender could demand full payment at any time. This is never recommended for large loans, but can be common in small, informal deals.
- Balloon payments. Some lenders may require borrowers to pay off a portion of their loan through regular monthly installments, followed by a larger, final payment to close the note on a certain date.
Thanks a lot – IOU!
Promissory notes may seem like an unnecessary step, especially if you’re lending or borrowing a small amount or it’s just between friends. However, it’s important to keep everyone legally protected, so put it on paper with the help of legal drafting tools that make exchanging money quick and simple.
Trying to sign a bill with someone far away or just looking for an easier way to digitize the process? With electronic filing platformsfilling out legal documents has never been easier.
