What is a Promissory Note?
The term “promissory note” refers to the financial instrument that represents a well-documented promise made by the borrower in the favor of the issuer to repay a specific amount of money, either on a particular date in the future or whenever the lender demands repayment. A typical promissory note should include all information pertaining to the indebtedness, such as the principal amount of the debt, applicable rate of interest, date, and place of note issuance, and maturity date of the note.
A promissory note can be considered a loan agreement or an IOU (informally). It is a legal loan document that states that the borrower has promised to repay the debt to the lender over a specific period of time. As such, this type of document is legally enforceable and the borrower is legally obligated to repay the loan as per the pre-decided terms and conditions of the loan document.
Features of Promissory Note
Some of the major features are as follows:
- It should be well-documented in writing as a verbal agreement/contract don’t have any legal implications. Basically, it is a promise made by the borrower to the lender via a written contract.
- It should clearly mention the sum of money that the borrower owes to the lender.
- The name of the borrower and the lender should be captured in the note. Basically, it should mention who will pay to whom.
- It should also have the date by which the borrower will repay the debt.
- In cases where the payment has to be done in instalments, the number of instalments should also be captured in the note.
- Lastly, the place of the commitment should also be there in the note.
Types of Promissory Note
There can be several types based on the purpose and nature of the transaction. In this section, we will discuss some of the major types:
- Personal Loan: These type of loans are extended by friends or family members. Although legal writings may seem avoidable when lending to close contact, a promissory note always acts a safety net for the lender.
- Commercial Notes: These type of notes are created while dealing with commercial lenders, such as loan agents or banks. In case of a default, these lenders are entitled to charge lien on the collateral until the obligations have been paid in full.
- Real Estate Notes: Similar to commercial notes, in these type of notes the borrower can offer real estate property as collateral. In case of failure to meet repayment obligations, the lender can rightfully keep the property until the obligations is cleared.
- Investment promissory notes: In these type of notes, the borrower raises funds for supporting business requirement. In case of a default, the lender has the right to take ownership of the borrower’s business until repayment of the debt obligation.
- Simple promissory notes: It is the most basic form of notes which is created as a written promise that the borrowed money will be paid back as per the agreement. Unlike the above mentioned notes, the purpose of the loan isn’t captured in detail.
Promissory Note Format
I _________[name of borrower], make commitment to pay _________[name of lender], the sum of $___________. Repayment has to be made in the form of _______[number] equal payments at the interest rate of __________[interest rate %] of $____________ payable on the ______[day of a month] of each month, beginning ________[date] until the total amount of the debt is paid.
IN WITNESS WHEREOF, I set my hand under seal this _________[day] of __________[month], _________[year] and I acknowledge receipt of a completed copy of this instrument.
Sign: [Signature of borrower]
Notary Public – SEAL
__________________________ My Commission expire
Name & address: [Party name] ______/______/_______
What is Included in Promissory Notes?
A loan promissory note should include the following:
- Name and address of both borrower and lender
- Amount of the borrowed money
- In the case of installments, frequency and amount of payments
- Details of collateral
- Signatures of both borrower and lender parties
When to Use ?
A promissory note is usually created for the purpose of documenting a personal loan, mortgages, car loans, student loans, business loans, etc. Basically, when a lender extends a large sum of money to a person or a business, then he/ she creates a legal record of the same in order to mitigate the risk of non-payment or default in the future.
Customization of a Promissory Note
As we have already discussed above that there are different types of notes and hence it is important that the right type of promissory note is created to fit the purpose of the transaction. It is better not to start from scratch and rather refer to an existing sample note as it helps in incorporating the right kind of legal language.
For instance, in the case of a loan with just a lump sum repayment on a specific date, a sample of a simple promissory note can be used. On the other hand, a demand promissory note can be used in cases where the obligation arise only when the lender requests the repayment. Similarly, more complicated promissory notes can be used for transactions, such as car loans and mortgages, that include amortization schedules, interest rates along other details.
So, it can be seen that there are different forms of a promissory note which changes based on the purpose of the transaction, details to be captured, and parties involved. Nevertheless, all these forms of promissory notes have one thing in common – they protect the lender’s money.
This is a guide to Promissory Notes. Here we also discuss the introduction and what is included in promissory notes? along with types and features. You may also have a look at the following articles to learn more –