What Is a Promissory Note?
A promissory note is a legal contract between two parties — one lending money, and the other promising to pay it back. If you’ve taken out a loan before, chances are you’ve signed a promissory note, too.
But promissory notes aren’t just for formal lenders. Any time you lend money to someone, you can draft up a simple promissory note to make sure they repay you. In order to be legally valid, though, you’ll need to make sure it has a few things on it first.
- A promissory note is a legal promise to repay a loan.
- The specific requirements for a promissory note vary according to state law.
- Businesses or individual people can use promissory notes when lending money.
What is a promissory note?
A promissory note is like an IOU, but with more legal backing. Rather than just listing out a loan amount and a name on the back of a napkin, a promissory note is an actual legal contract. It lists out the basic details of a loan that someone is agreeing to, and it’s signed by both parties so it can hold up in court if needed.
Anyone can use promissory notes when lending money to others. It’s a good idea if you’re lending money to friends and family. If you apply for a loan from a bank or other formal lender, they’ll almost certainly require you to sign a promissory note as a condition of receiving the loan, too.
What’s in a promissory note?
The specific information in a promissory note varies depending on the lender or the person making the loan. Most list the same general information:
- Names: This identifies the two parties involved in the loan: the lender and the borrower. Make sure to include everyone’s legal name and contact information, such as mailing addresses, phone numbers and email addresses.
- Loan amount: This specifies how much the borrower is borrowing and must repay (with interest).
- Collateral: If you’ll be using collateral for the loan, it’ll be listed here. A mortgage promissory note, for example, uses your home as collateral.
- Effective dates: This is when the loan takes effect — i.e., when the money is disbursed to the borrower — along with the anticipated end date.
- Interest rate: This explains how much interest the lender is charging, expressed as a percent. Depending on the loan type and what state you’re in, usury laws may specify a maximum interest rate that can be charged.
- Payment terms: How the loan will be repaid — e.g., in installment payments, a lump sum, on demand.
- Signatures: A promissory note isn’t valid unless both parties sign. You don’t necessarily need to get it notarized, but it also doesn’t hurt and can provide additional legal protection.
If you’re making a promissory note for a loan you’re giving to someone, it’s a good idea to include more information, such as payment due dates, grace periods, etc.
Promissory note vs. loan agreement
Promissory notes and loan agreements (also known as “credit agreements”) are similar, but not exactly the same thing. A promissory note is a legal promise to repay the money, along with a basic description of how that’ll happen. For small loans between friends and family, that may be enough on its own.
A loan agreement, on the other hand, lists out the detailed terms of a formal loan. It includes more information, such as how exactly the lender’s fees work, how the lender reports the loan information to the credit bureaus, what happens if the borrower defaults, how the lender takes possession of any collateral, etc.
Often, you’re required to sign both as a condition of being approved for a loan.
If you take out a loan from a formal lender, they’ll generally report your payments to one or more credit bureaus. This can impact your credit in a good way or negatively, depending on how you manage the loan.
You can easily monitor your credit score using LendingTree Spring to see how your loan affects your score over time.
Types of promissory notes
Promissory loans can be used for just about any debt, whether it’s a simple loan between friends and family or a more complex loan involving collateral and a small business lender. Here are some of the different types you might see:
- Simple note: The borrower repays the loan in a single lump sum payment.
- Installment note: The borrower makes regular pre-set payments, like monthly payments for a personal loan.
- Secured note: The borrower offers personal property as collateral for the loan. If they default, the lender has the right to claim ownership of the collateral.
- Demand note: The lender can order the borrower to repay the loan at any time of their choosing.
- Unsecured note: The borrower doesn’t use collateral for the loan, leaving the lender with fewer options to get their money back if the borrower defaults.
- Open-ended note: Used for debts that don’t have pre-set end dates or payment structures. Often, these are used for things like open lines of credit or HELOCs.
- Master Promissory Note (MPN): The specific document that the Department of Education requires students to sign when taking out federal student loans.
Keep in mind that several of these terms can apply to the same debt. You could describe a federal student loan as being backed by a Master Promissory Note or an installment note, for example, since student loans are also paid back with regular monthly payments. A Master Promissory Note is simply a subtype of installment note.
How are promissory notes enforced?
Promissory notes are generally enforced through the court system if something goes wrong. It’s a good idea to talk to a lawyer if someone listed on the promissory note defaults. An attorney can help advise and represent the person loaning the money — and, on the borrower’s side, can offer options and advice on whether the contract is even legally enforceable.
How to write a promissory note
Writing a promissory note isn’t rocket science. But in order to ensure your promissory note’s validity, it’s a good idea to make sure you’re following the correct steps. If you don’t do it right, it could be declared unenforceable by a court.
- Research your options: You can write a promissory note on your own from scratch, modify a pre-written promissory note template or hire a lawyer to do it for you.
- Draft the promissory note: Write the promissory note and save copies as a backup, just in case. Make sure to include, at a minimum, the details listed in the above section.
- Check for enforceability: Just because it’s signed doesn’t mean it’s valid. Make sure your promissory note complies with state laws, that it’s detailed and that it doesn’t contain overly unfair terms.
- Have both parties sign: A promissory note isn’t valid unless both parties sign it. Make copies, too, in case someone loses the signed version.
Promissory note templates
Here are a few resources where you can find templates to help ensure you’re doing it right:
- PromissoryNotes.org has free basic promissory note templates for each state.
- LegalZoom offers a range of promissory note templates for different types of loan structures.
- LawDepot offers customizable promissory notes for different uses, such as small businesses or lending to friends and family.
Frequently asked questions
It’s not required, but it’s a good idea. It sets everyone’s expectations up front and, if needed, gives you legal backup if necessary.
Only if you’re agreeing to the terms of the contract. A promissory note requires some evidence that you’re agreeing to its terms, which usually means signing the document. Without a signature, it’s not legally valid.
Not necessarily, but they can be. It just depends on your (or your lender’s) comfort level with relying on a physical or digital signature alone, which is generally still legally valid.
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