6 Basics of Promissory Notes

What Is a Promissory Note?

When you’re thinking about providing someone with a loan that they can use to get a car or go to college, you might want to think about first creating a promissory note that will act as a kind of legal record for the loan while also making sure that you are properly repaid in the allotted time. Before you use a promissory note template to create one of these notes, you should first know more about a promissory note and what the legality of such a note is. 

Breaking Down a Promissory Note

Promissory notes are a type of loan agreement or note that states that the borrower of the loan promises to pay back a certain amount of the money by a specific time frame. For instance, the promissory note could state that the borrower agrees to repay a total of $5,000 over a period of four years. While this document is very similar to a basic IOU, it’s considered to be a legally binding document, which means that its terms can be enforced and are expected to be followed. 

A promissory note can be used for an array of different types of loans, which include car loans, mortgages, business loans, and student loans for college. It’s also possible to use a promissory note when making a personal loan with a friend or family member. If you are about to lend a substantial sum of money to a business or another individual, a promissory note gives you some protection that heightens the possibility that you will be repaid at the right time. 

The Different Types of Promissory Notes

There are a wide variety of types of promissory notes that you could create, each of which includes different language that outlines different terms. When you’re thinking about using a promissory note to add some extra security to your loan, there are four basic types for you to consider, which include a simple promissory note, an unsecured promissory note, a secured promissory note, and a demand promissory note. A simple note is one where a standard agreement is made to repay the loan amount as a lump sum by a specific date. If you loan a family member $3,000, a simple note could require the individual to pay back the entire loan by this time next year. Payment schedules don’t factor into simple notes.

On the other hand, a demand promissory note is one wherein payment is due whenever the lender requests for the borrower to repay the loan amount. However, these notes usually require the lender to provide the borrower with a fair amount of notice that the loan will need to be repaid. You should also know about secured and unsecured notes. An unsecured note is one that isn’t backed by any kind of collateral, which opens up a certain amount of risk for the lender. 

Instead, it’s possible for the lender to obtain the money they’re owed through a debt collection process, which could include everything from filing a claim within a small claims court to creating a debt settlement agreement. A secured promissory note is one wherein terms will be included in the note to use certain types of collateral like a deed of trust or mortgage in the event that the loan is not repaid on time. When terms have not been met, the collateral can be seized and sold so that the lender can recoup the money that they’ve lost. 

What Is the Legality of a Promissory Note?

In most cases, a promissory note will be legally binding as long as the offer is clearly stated within the note and has been accepted by the borrower. While the loan terms for each promissory note will be different, these terms are enforceable as long as the terms are clear and the borrower has signed on the dotted line. More complicated promissory notes will include amortization schedules and interest rates on the initial loan. If all of the conditions of the loan are addressed within the promissory note, the promissory note becomes a legally binding contract. 

Can I Write My Own Promissory Note?

When you’re thinking about writing your own promissory note, it’s highly recommended that you use a promissory note template that will guide you through filling out the document and will automatically include the necessary legal terms. While it’s certainly possible to draw up your own promissory note, your chances of the note being enforced will substantially lessen by going this route. It’s also important to understand that the IRS can have a say on what your promissory note looks like. If the promissory note is for a low amount of money and you’ve decided to charge no interest, the IRS may sometimes affix the note with its own interest rate that will be expected to be paid by the borrower. 

While you shouldn’t try to write your own promissory note unless you’re using a template, the main facets of a promissory note include:

• The names of the lender and borrower
• The date at which the loan must be repaid
• The amount of money that needs to be repaid
• Any interest rate that’s attached to the loan
• Dates that dictate when first and subsequent payments must be paid if a payment schedule is being used
• The date at which the promissory note comes to an end

While it’s possible for additional elements to be included in a promissory note, these are by far the most common elements of a promissory note.

What Can Make a Promissory Note Invalid?

While promissory notes should be valid as long as the terms of the agreement have been clearly stated and agreed upon by the borrower, there are a variety of things that can cause the promissory note to become void. Among the most common reasons for a promissory note to be invalid is because the lender has lost proof of the note having ever existed. In the event that the borrower stops making payments and you decide to file a lawsuit in order to claim the money that you’re owed, you will need to prove that the promissory note existed. While it’s possible that a copy of the original could be accepted by a judge, the original note will typically need to be provided. There could also be various flaws within the note, which could be anything from charging an interest rate that’s too high or the borrower not signing the document.

Difference Between a Promissory Note and a Loan

A promissory note acts as a type of loan agreement. However, a promissory note isn’t quite as detailed as a loan agreement. While both of these agreements are considered to be legal documents, a loan agreement goes further than a promissory note by requiring both the lender and borrower to sign the document. With this information in hand, you can get started on creating a promissory note.

Let us help you take the guesswork out of creating your own promissory note by using one of our promissory note templates to do the heavy lifting.