A promissory note - like a loan is a written agreement that the borrower signs promising that he will pay back his debt. One of the main differences between the two documents is that promissory notes tend to be for simpler and straight forward transactions while loans are for more complex contracts that almost always require legal advice.
Like loans, promissory notes are legal transactions and therefore legally binding in a court of law. If the borrower fails to pay back his or her debt, the lender can take him or her to court for loss of funds.
Unlike loans, promissory notes do not have to be drafted by a lawyer. They can be written by the lender and signed by the borrower without getting a lawyer or bank involved.
While promissory notes are simpler to create than loans they must include key details in order to be upheld in court. In order to create a note – follow these steps below. If this is your first promissory note- it may be helpful to get legal advice before having the borrower sign it.
- Who should be named in the note? Unlike a loan, only the borrower signs a promissory note
- How much is the loan for? This detail must be included in the document in order for the borrower to know how much he has to pay back. Without this key piece of information it is very unlikely a judge would rule in the lender’s favor if the note ever gets contested in a court of law.
- How Long Does the Borrower Have to Pay Back his Debt? What are the terms of the promissory note? How long does the borrower have to pay back the loan before he is considered in default? By having a set amount of time the borrower is able to plan a strategy to ensure that they pay back their debt on time and in full.
- How will a borrower pay back their loan? Weekly? Monthly? In cash, by check?
- Include any interest that the borrower must pay: While interest is not a must in every promissory note- it must be called out if it is included.
- Is any Collateral involved: Collateral is an object that the borrower agrees to give the lender in the case he fails to repay his debt. If he defaults on his payments the lender has the legal right to seize the collateral as his own. Collateral can be houses, cars, or objects that cost around the same amount of money that is being borrowed.
- When to include a security agreement? If collateral is involved in the promissory note then a security agreement should also be present. This outlines the terms of how and when the lender can seize the collateral.
- Terms regarding late payments and default payments: It’s important to be clear in the promissory notes regarding late payments and/or default payments. How many times can the borrower miss a payment before he is considered in default? Once in default- how soon can the lender seize the collateral?
While less of a headache then a loan – promissory notes should not be taken lightly. If you are a lender ensure that you have taken the necessary steps to ensure that in the case of default your note will be upheld by a judge in the court-of-law. If you are the borrower- ensure that the terms are satisfactory and that you can meet all of the terms listed out.