What Is a Promissory Note and How Do You Get One?
A promissory note is a signed legal document between two parties that states how much money is being borrowed, when and how it will be paid back and what happens if there’s a failure to repay.
A handshake or a verbal promise to repay might be enough in some cases, such as when you borrow a small amount of money from a friend. But a written agreement between the parties should be signed, especially if the transaction involves larger sums or a business is involved.
How does a promissory note work?
Financial institutions typically provide their own promissory notes when you take out personal loans or student loans, lease or buy a car or take out or refinance a mortgage. But if you are lending or borrowing money with a friend or colleague — or want to pay for something over time like for a local contractor — you can find promissory note templates online.
A standard promissory note includes:
- The name and contact information of the person borrowing the money
- The name and contact information of the person or financial institution who is lending the money
- The date the money was borrowed
- The amount of the loan
- The payment dates
- The interest amount
- The final due date
- Any penalties if the loan is unpaid
- The signature of the borrower
- Whether the loan is unsecured or secured
“Secured promissory notes mean that there is security or collateral used to ensure repayment — such as a mortgage on a house or some pledge of another asset,” Mark A. Hakim, attorney at Schwartz Sladkus Reich Greenberg Atlas in New York City, wrote in an email. “With a secured note, should a maker default in the terms of the note (e.g., does not pay when due), the security (depending on how the mortgage, pledge or other instrument is drafted) is subject to forfeiture.”
Is a promissory note legal?
Yes, a promissory note is a legal, binding agreement, even if it’s a handwritten note signed by both parties on a cocktail napkin.
“However, it would be foolish to sign a handwritten promissory note as it is easier to add language to a handwritten note after the fact as opposed to a typewritten one,” said Vincent J. Averaimo of Milford Law in Milford, Conn.
If the terms of the loan are complex or you have borrowed a large sum of money, you should have a lawyer review the promissory note before you sign it, although this step is not required by law.
“What would make the note more complex are its terms,” said Neil B. Garfinkel, an attorney with Abrams Garfinkel Margolis Bergson in New York City. “For example, you want to borrow $100,000, but we agree on an adjustable rate the first year that changes the second year.” Garfinkel also advised having a promissory note notarized, so there is a witness during signing.
Whether the promissory note is between friends or with a financial institution, the onus is on the borrower to be aware of and stick to the terms of the agreement. “Should the borrower fail to realize any of these changes, he will still be bound by the terms after execution and acceptance of the money — barring any legally appropriate right to cancel,” said Averaimo.
Broken promissory notes
Even a signed promissory note doesn’t guarantee repayment of the loan. So how (and whether) the lender can collect on broken promises will depend on whether the loan is secured or unsecured.
“If it’s an unsecured loan, you can sue the person to enforce the promise,” said Garfinkel. For debts up to $25,000, small claims court can be a viable option, depending on the laws in your state.
If there is a secured promissory note, whether it’s a co-op, house or car — you can start foreclosure proceedings, something anyone can do, according to Garfinkel. “The holder of the note, regardless of whether it is a corporation or an individual, can sue the person who signed the note if they don’t meet the obligations of the note,” he said.
Notably, a broken promissory note agreement with a financial institution can also be reported to credit bureaus and negatively affect your credit score. But a promissory note between two individuals cannot.
When a friend asks to borrow a few bucks, it might make sense to just hand it over and rely on them to pay it back on time. But things happen, so whether you are the one who is borrowing or lending money, make sure to protect yourself, get all the transaction details in writing and have all the parties sign on the dotted line.