Last updated May 5, 2022
What is a Promissory Note?
A Promissory Note documents the borrower’s legally binding promise to repay a loan under certain terms and conditions. Unlike an IOU that only acknowledges a debt amount, a Promissory Note details the consequences of failing to repay a loan.
Typically, Promissory Notes include the original loan amount, applicable interest rates, late fees, a repayment plan, and details about using collateral.
A Promissory Note is also known as a/an:
- Demand note
- IOU note
- Promise to pay agreement
- Notes payable
- Commercial note
What is a demand Promissory Note?
When using a demand Promissory Note, the borrower is only obligated to pay when the lender demands payment. Once the lender gives notice to repay, the borrower must repay the loan within the specified number of days.
This type of loan might not work for everyone, so think about whether or not a borrower will be able to pay back the loan on demand when creating a Promissory Note.
What are Promissory Notes used for?
Customize LawDepot's Promissory Note template to suit a variety of purposes, including:
- Business loans, such as capital for a startup business
- Vehicle loans for a vehicle, boat, or other motor vehicle
- Real estate loans, such as a down payment on a home
- Student loans for tuition and other educational expenses
- Debts or bills, such as credit card debt
How are Promissory Notes used in real estate?
When purchasing real estate, a Promissory Note is often called a mortgage note or mortgage Promissory Note. Whereas a mortgage is secured by property, a Promissory Note contains the details of a loan and the borrower’s promise to repay. A Promissory Note is often used during the mortgage process by banks.
How do I write a Promissory Note?
You can create a Promissory Note as a lender or borrower by following these steps:
1. Select the location
Our Promissory Note template will customize your document specifically for the laws of your location. Select the state where the loan is taking place.
2. Provide party details
Describe the relationship between the lender and the borrower (e.g., friend or family member). Include the names and addresses of all lenders and borrowers.
Additionally, if anyone is co-signing the loan, include their name and address too. A co-signer agrees to be responsible for the loan if the borrower breaches the terms of the agreement.
3. Establish the terms of the loan
A Promissory Note allows you to establish a loan in detail. Provide the following information.
- Loan amount: Include the total amount of the loan.
- Interest: If the loan accumulates interest, include the compound rate and how often the interest will accumulate.
- Loan date: Provide the date the borrower will receive the loan from the lender.
- Repayment: Include how the borrower will repay the loan (e.g., single payments or regular payments). If the borrower is making regular payments, provide the payment frequency (such as monthly or weekly). Provide the date on which the borrower will make the first payment and how many payments the borrower will make.
- Early repayment: Establish whether or not the borrower can make a lump sum payment to repay the loan early.
- Insurance: Depending on the purpose of the loan, the lender may have the option to require the borrower to have insurance. For example, if the loan is for a motor vehicle, the lender can require the borrower to maintain insurance on the vehicle.
4. Include final details
These additional details aren’t required, but you may still choose to include them in your Promissory Note.
Collateral
Determine whether or not the borrower will require collateral. Collateral is an asset or property offered by the borrower to secure repayment of a loan.
Securing the Promissory Note with collateral allows the lender to receive compensation if the borrower fails to make payments. It's most useful when there is a high risk that the borrower will default or if they’re receiving a substantial loan.
If the lender doesn’t secure the loan with collateral, they’ll need to go to court before seizing any of the borrower's assets. Avoid using real estate or land as collateral.
Late payments
State whether the lender will charge a penalty for late payments. The penalty can be a late fee or an interest rate increase.
5. Sign the document
Once your document is complete, sign the document. Depending on your loan, you may choose to sign your document in front of a witness or notary public.
A witness can be any third party with no financial or other interest in the document.
A notary public is a public officer that specializes in verifying signatures and deterring fraud. They’ll give you the strongest form of signature verification.
While witnesses are rarely legally required, a witness signature can strengthen the evidence of a binding agreement in case of a dispute.
Should I use a Promissory Note or a Loan Agreement?
People typically use Promissory Notes for loans from non-traditional money lenders, like individuals or companies, instead of banks or credit unions. These short- or long-term loans often help people achieve various personal and business goals.
A Loan Agreement is more comprehensive than a Promissory Note and includes clauses about the entire agreement, additional expenses, and the process for amendments (i.e., how to change the terms of the agreement). Use a Loan Agreement for loans of a large amount or that come from multiple lenders.
