Borrowing and lending money is something most people do at some point in their lives. Whether it’s a formal loan from a bank or between friends and family, loan records can help ensure that all lenders are eventually repaid.
When large sums of money are exchanged informally, such as lending cash to a sibling to buy a car or helping a friend with rent, a verbal agreement alone is not enough. Instead, legal documents like promissory notes can be used to hold both parties accountable for their roles in the transaction.
What is a promissory note?
A promissory note is a legally binding contract in which one party promises to pay a certain amount to another party periodically or in full by a specified date. The note contains all the details about the loan, including the amount, interest on the loan, maturity date, and payment schedule.
Lenders are not required to sign a promissory note, but borrowers must sign it because it is a written record promising to repay the money. Because the promissory note is legally enforceable, it is important that all details are correct before the borrower signs it.
Even if the loan is between friends or relatives, it is best to consult a lawyer.they use legal document creation software Ensure that the relevant details are included in the contract and include the necessary signatures to bind the promissory note.
When is a promissory note used?
For any type of financial loan, a promissory note can be used as a stand-alone document or as part of the documents required when borrowing a large amount of money. big ticket items. Promissory notes are used in both personal loans and business transactions to provide legal protection to the lender.
The most common uses of promissory notes are:
- real estate. As part of the mortgage process for a home or business investment, the buyer signs a promissory note stating their obligation to repay the money they spent on the property.
- student loan. When you take out a higher education loan, you create a promissory note as a promise to repay the funds. Federal loans often allow students to sign a master commitment, which covers the loans they will receive over the next 10 years of the student’s enrollment.
- Purchasing office equipment. Loans taken out by a business to finance necessary operating equipment involve commitment financing. Similar to personal loans, these notes state that the business is responsible for repaying the entire amount by a certain date.
- working capital. Some businesses may take out loans to support their operations, especially during the off-season or when starting a new company. Money serves as a fund for essential daily expenses until income replaces it. These loans have their own promissory notes.
Many people choose not to use a promissory note when lending money to friends or family, even if it’s a large amount of cash. However, this is a risky move and there is no guarantee that you will get that money again. And without a promissory note, there’s nothing you can do if it’s not repaid.
For small amounts, a memo is usually not necessary. But when it comes to money you’ll miss out on if you don’t pay it back, a promissory note solves the problem nicely.
Types of bills
Depending on the type of loan, different types of promissory notes are required to set the terms of repayment for the borrower.
simple
This is the most basic type of promissory note and is typically used for small loans by a single borrower. When two individuals exchange money, all they need is a simple note. A simple promissory note can contain minimal details, such as amount, repayment terms, payment schedule, and names of parties involved.
open end type
An unlimited commitment is more like a line of credit than a traditional loan. Borrowers only receive a portion of the full amount upfront, but can receive additional money later if they need more while repaying the original loan. This is easier to manage than taking out multiple loans with different promissory notes.
master
If a borrower needs multiple loans, the borrower and lender can use a master promissory note as a continuing agreement. This can cover multiple loans between the same parties over a period of time, such as individual student loans.
Safe
Secured promissory notes usually come with better interest rates than other types because you have to pledge something of value as collateral as part of the loan. If the borrower fails to repay the money, this secured note allows the lender to obtain collateral in lieu of the outstanding balance owed.
Unsecured
An unsecured promissory note does not require the borrower to post any collateral, but it does leave the lender with legal options if the borrower fails to repay.
These promissory notes are common in real estate transactions because the mortgage is used to secure the loan rather than as additional collateral. If the mortgage is not paid, a lien is placed on the property and the lender can foreclose on the property and get their money back.
Information contained in a promissory note
The basic elements of the contract should also be included in the promissory note. Although additional details may be required depending on the type of note, a promissory note should at least include the following:
- Lenders and borrowers contact details. The first section of the promissory note states who is borrowing the money and who is lending the money, along with the date of the signature.
- Total loan amount. Lenders and borrowers must agree on the total amount of money to be exchanged.
- Maturity date. This is when the promissory note ends. The full amount must be repaid by this date. Some promissory notes may also list this as a “due date.”
- Fees, interest details and penalties. It lists the fees associated with creating a promissory note, interest rate details, and penalties that apply if the borrower defaults on the payment agreement.
- Repayment terms. These provide all the information about how exactly the borrower will repay the money. Most large promissory notes are paid in weekly, monthly, or quarterly installments. If the amount is small, you can pay it in one lump sum by a set date.
- Repayment start date. This date is important to the borrower because not all repayments begin immediately after signing the promissory note.
- Governing Law or Jurisdiction of the Memo. Where you sign the promissory note is very important. If a lender needs to take legal action against a borrower, this information will outline which jurisdiction (or governing body) is responsible for overseeing the legal process.
- Borrower’s signature. Only the borrower signs the promissory note because it is a promise to repay the money.
If you use a secured promissory note, you must include details about the collateral. The master promissory note also contains more complex information about the term of the note and the type of loan it covers.
How will the promissory note be repaid?
As with traditional loan agreements, borrowers can repay in several ways. In addition to lump-sum and installment payments, on-demand and balloon payments are also available.
- On-demand payment deadline. If the promissory note does not include specific payment information, the lender may demand full repayment at any time. This is never recommended for large loans, but may be common in smaller, informal arrangements.
- balloon payment. Some lenders may require the borrower to pay part of the loan in regular monthly installments and then make a larger final payment to close the promissory note by a certain date.
Thank you so much – IOU!
A promissory note can feel like an unnecessary step, especially if you’re borrowing a small amount or just between friends. But legal protection for everyone is important, so get it down on paper with legal documentation tools that make transferring money quick and easy.
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