How to Write a Promissory Note?

A Promissory Note: What Is It?

You might have signed a promissory note when you borrowed money from a lender.

All the details of a loan appear in a promissory note, a legal agreement. A promissory note outlines the loan amount, repayment obligation, charges, and what the lender must do if the borrower doesn’t pay. The promissory note you sign as a borrower shows you agree to its terms and promise to repay the loan.

It is most common to use promissory notes when we borrow money from a bank or lender. However, sometimes we lend money to family and friends without formal agreements.

It’s essential to have a promissory note for situations like these, though. What if your nephew abandons you with your $5,000, for instance? Or what if your aunt doesn’t pay you back when you’d appreciate it?

 

The Promissory Note Process

Between the informalities of an IOU and the rigidities of a loan contract, promissory notes fit into this category. IOUs simply acknowledge a debt and the amount owed to another party. In addition to a promise of payment on demand or at a future date, promissory notes include steps for repayment (such as a repayment schedule).

There are many promissory notes, from simple written promises to more complex instruments regulated by state or federal securities bodies.

 

Unsecured Vs. Secured Promissory Notes

Secured and unsecured promissory notes are different. Secured promissory notes describe collateral—typically property—used to secure the debt. Borrowers can lose their property if the borrower doesn’t repay the loan. For example, if the borrower owns a car, the lender can use the car as collateral.

If a person defaults on an unsecured promissory note, the lender may collect the debt through traditional methods. Promissory notes remain on the books until the debt is repaid, and most people will consult with an attorney before drafting one to ensure it adheres to state or federal laws.

 

Promissory Notes: Types

A promissory note’s type often reflects the type of loan it is for. Here’s a list of some common types:

 

Simple Promissory Note:

An agreement to repay money borrowed in an agreed-upon way consists of a simple promissory note, which does not specify the reason for the loan.

 

Student Loan Promissory Note:

Student loan promissory notes, or master promissory notes, are agreements between a borrower and the government that they will repay their student loans with interest. Students may create student loan promissory notes with their parents or relatives who provide them with education funding. Still, most student loan promissory notes are between a borrower and the government.

 

Real Estate Promissory Note:

An owner of a property uses the promissory note as collateral. If the borrower defaults, the lender may place a lien on the property. This information becomes a public record and negatively impacts the borrower’s credit.

 

Personal Loan Promissory Notes:

When friends or family members lend each other money, they sign a personal promissory note.

 

Car Promissory Note:

The car promissory note acts as an agreement between the borrower and the lender during the sale or exchange of a car. Other vehicles also create vehicle promissory notes for loan recording.

 

Commercial Promissory Note:

If a borrower defaults or cannot make timely payments, a commercial promissory note allows the borrower to borrow money from a commercial lender. In addition to demanding full loan and interest payment, the lender may also attach a lien to the borrower’s assets until the lender receives all repayments.

 

Investment Promissory Note:

Business owners often use investment promissory notes instead of business loans to raise capital. Investing in a business reduces risk. The investor can take ownership of the company if the borrower fails to repay. This ensures the investor receives a return on their investment over a specific period.

There are also differences in promissory notes based on the type of payment:

 

Installment Payment:

Promissory notes with installment payments often occur when purchasing expensive goods. It is possible to pay in installments or batches.

 

Installment Payments with a Final Balloon:

Payment primarily applies to mortgage loans. Borrowers pay small installments before paying back a large sum all at once.

 

Due on a Specific Date:

The repayment of a loan or debt is due on a specific date with a due on a specific date promissory note.

 

Due on Demand or Default:

It is a promissory note usually used between family and friends to lend a small amount of money.

 

Promissory notes: When Should You Use Them?

A promissory note is the best option when you lend someone money for which you expect repayment. Also, a promissory note is the best option when you borrow money from someone who could be upset if you don’t repay it.

 

 

It is not uncommon for most people not to sign promissory notes for small amounts, such as spotting someone at dinner or filling up a tank of gas. However, if you lend someone a few hundred or a thousand dollars, you must write a promissory note to ensure everyone understands what to expect of you.

 

What Are The Parties To A Promissory Note?

It is common for two, or sometimes three, individuals to sign a promissory note:

 

Drawee:

A drawee is a lender.

 

Drawer:

In a promissory note, the drawer agrees to pay the drawee when it is due.

 

Payee:

In this case, the drawer (or borrower) has designated the payee as the recipient of the money.

 

Example:

Joan’s company, XYZ, is in the startup stage. Stella has signed a promissory note with Joan, pledging to lend her $1,000 to help her start XYZ. On the promissory note, Joan is the borrower or drawer, while Stella is the drawee. As a result, if Stella transfers the promissory note to her daughter, Jill is the payee of the note.

The drawer or borrower generally receives the promissory note once the amount owing has been repaid and the drawee or payee cancels the note.

 

A Promissory Note: What Does It Include?

It should include all the details of the loan, as well as the repayment terms. The promissory note may include the following:

• Borrower’s and lender’s names and addresses
• Date of maturity
• Borrowing amount
• Schedule of payments
• Calculating interest rates
• The prepayment process
• Charged interest for overdue payments
• The default setting
• Governing law for promissory notes, waivers, and amendments

 

Preparing the Promissory Note

You do not have to write from scratch to write a promissory note. You can use a template or use an online form instead. Before you start, you must gather some information and decide how the loan will be structured.

A promissory note typically includes both the lenders (and payees) and borrower’s names and addresses, as well as the following basic terms and conditions:

• Money lent.
• Unless your state allows higher interest rates, you should not charge interest.
• Collateral or “security” is used to secure a promissory note.

In addition, you will include the terms of the promissory note, including:

• Payment amounts can range from one-time to periodic payments, such as monthly.
• Due dates for payments.
• Please send payments to this address.
• Late payment penalties.

The promissory note also explains what is considered a “default” event, including the lender’s legal remedies in case of a default, such as repossessing the collateral in the event of a default.

 

The Signing and Storing Of a Promissory Note

To ensure the borrower’s signature is authentic, you may want the borrower to sign in front of a notary. If you need to find the promissory note, keep it with your other essential papers. The lender keeps the original, and the borrower should receive a copy.

 

Changing a Promissory Note

It is possible to modify the promissory note terms over time. You may want to increase the interest rate or lengthen the loan term. To enforce oral changes in court, always put a change in writing and get the borrower’s signature.

A promissory note cannot change without the borrower’s written agreement. The best way to change a note without the borrower’s written agreement is to amend the promissory note. Please refer to the original promissory note when making the changes and list them. Ensure the borrower signs the amendment and keeps it with the original note.

Promissory notes provide peace of mind that there is legal recourse if anything goes wrong, as they force you to think through the details of a loan before money changes hands.

 

Promissory Note Examples

There are several situations in which a promissory note may be helpful:

 

Student Loans:

A student loan promissory note confirms your repayment of student loans if you borrow money for educational purposes.

 

Car Loans:

You can use a promissory note for a car loan to assure the lender that you will repay the loan within set terms.

 

Business Loans:

A business promissory note will guarantee repayment to the lender within the set terms and timelines if you borrow money to invest in or start a business.

 

Personal Loans:

To promise repayment under set terms, you can use a personal promissory note when borrowing money from family and friends.

 

Repayment of Promissory Notes

It is possible to repay a promissory note in several ways, but you will usually repay the principal and interest. You may be required to pay interest on the promissory note daily, monthly, annually, or another way. Some states may cap interest rates. If you have questions about how the promissory note’s repayment schedule will affect you, consult an accountant or attorney.

Installment note:

Most repayments occur through installments, in which the borrower makes regular payments. Both the repayment schedule and interest payment can differ.

 

Simple note:

If you have a smaller loan, you might arrange lump-sum repayment on a specified date, meaning you will repay the entire amount then.

 

Open-ended note:

You can borrow against this promissory note over time, repaying your draw plus interest when due.

 

Demand note:

Promissory notes can specify “on demand” repayment, meaning the lender can ask for repayment anytime.

 

Are Promissory Notes Good or Bad?

A promissory note can be advantageous if an entity cannot obtain a loan from a traditional lender like a bank. The lender does not have the means and scale of financial institutions’ resources, making promissory notes much riskier. In the event of default, both the issuer and payee may face legal issues, so it is essential to have a promissory note notarized.

 

Are Promissory Notes Guaranteed?

The promissory note can be described as a legal document signed by the person who is borrowing it, committing to pay back the loan in the format and the manner stipulated within the document. In addition to the note, the borrower may also provide a personal guarantee, a promise to pay the lender. The lender can pursue the guarantor in court if the guarantor fails to abide by the promissory note terms.

The house typically secures mortgages. The bank may take possession of your house if it cannot make mortgage payments. On the other hand, vendor notes are secured by the goods that the borrower will buy. A vendor note will return the goods if the borrower does not meet its terms. Fontaine warns that since promissory notes are generally not secured by tangible assets, lenders’ risk is more significant.

 

Bottom Line

In a promissory note, one party promises to pay a certain amount at a future date. While financial institutions may issue promissory notes, they can also be used by other organizations or individuals to confirm a loan’s terms. However, the average investor should be cautious and thoroughly research promissory notes as investments. Anyone can issue a promissory note.