Q&A: What is a Promissory Note?

Question: What is a Promissory Note?

Answer: Put simply, a promissory note is a written (and signed) promise from one party to pay a sum of money to another party. The promise is to pay either on a specific date or on demand (if certain conditions are met).

The person who is promising to pay a certain amount is called "the maker" or "the borrower." The person who is receiving the promise is called "the payee" or "the holder." A promissory note can be used in a variety of situations.

What Is a Promissory Note Used For?

A promissory note is like an IOU in a way, but it's a legally binding contract. The promissory note includes the specific terms of the agreement and the details about when the payment is due.

You might use a promissory note for any of the following situations:

  • Personal loans. If you're getting a loan from a friend or family member, a promissory note documents the agreement. In the event of confusion over the terms, it might even make sure the relationship doesn't suffer.
  • Bank loans. Commercial lenders, such as banks, usually require a signed promissory note when you borrow money.
  • Auto loans. The promissory note documents the transaction and spells out the repayment terms. In a situation like this, the note might include language that makes it clear the auto will be repossessed if the borrower doesn't pay as agreed. This is an example of a promissory note that's secured by property.
  • Student loans. This could be a loan from a third-party or from a parent or other relative.

And there are different types of loans, too. For instance, with property, you could use a promissory note to cover an installment agreement. This agreement might include interest or the holder of the note could decide that no interest will be charged. Or you could set up the note to document a lump-sum payment.

The exact details in a promissory note depends on the nature of the loan, but in general, here's a partial list of the types of information you'll find:

  • Identification of the parties involved, including addresses.
  • The amount of money borrowed.
  • A repayment schedule, if applicable.
  • The interest rate being charged, if any.
  • The date for a lump-sum payment, if that's the agreement.
  • The security for the loan, if applicable.
  • What happens if the borrower defaults on the loan.

As you can see, before the note can be written, the two parties need to have an in-depth discussion regarding the terms. Be informed about this ahead of time, so if you're asked, "What is a promissory note?," you'll be prepared and look credible.

Credibility when dealing with a legal situation is always important, but when you're dealing with a friend or a family member, it's also wise to focus on protecting the relationship. Finances and family are often tough waters to navigate. With a promissory note signed by both parties, the chance of a misunderstanding is diminished.

Do You Need a Lawyer?

There are situations where getting a lawyer to draw up the promissory note is a good idea. If the amount is large and the terms are complex, then a lawyer might be a good idea for your own protection.

If your situation is straightforward and the amount isn't large, then you might be able to use one of the templates online. Use your best judgment depending on the circumstances. If you decide to proceed on your own, there are many templates and samples online that you can download for free or for a cost. For instance, check out LawDepot.com, Nolo.com, and SuzeOrman.com.

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