For loans secured by real estate, LawDepot’s Mortgage Agreement documents specific terms and conditions, including the use of the property as collateral.
LawDepot’s loan documents cover other lending situations.
Should I use a Promissory Note?
A Promissory Note benefits both lenders and borrowers because it sets clear terms for repayment. Verbal agreements can be valid, but either party can easily forget details from a conversation.
Benefits of a written note include:
- Flexibility: Each note can be tailored to the loan, with payment terms the parties agree on.
- Fewer disputes: Clear terms reduce confusion about what was agreed.
- Stronger relationships: Sets expectations and helps preserve relationships with family, friends, and colleagues.
- Legal proof: The note serves as proof of the loan’s terms if the lender needs to take action to recover payments.
A note can also include a co-signer. A co-signer is a third party who agrees to assume responsibility for the borrower’s debt if the borrower misses payments or breaches the note.
Anyone co-signing a loan may have to pay the full amount owed, plus late fees or collection costs.
Is a Promissory Note legally binding?
Yes. A Promissory Note is a legally binding contract if it meets your jurisdiction’s legal requirements. Additionally, a note must typically include:
- Names and signatures of both parties
- Principal loan amount
- Repayment terms and schedule
- State-specific legal requirements
Promissory Note laws vary by state. They may include:
- Usury rates: These are limits on the interest rate a lender can charge.
- Statutes of limitations: These set the time limits for enforcing claims for late payments.
Promissory Note laws by state
Promissory Note laws differ by state, including rules on enforceability, remedies for breach of contract, and the statute of limitations, meaning how long a lender has to sue for outstanding payments.
For example, the general time limit to sue on a written contract is:
Some promissory notes may fall under different time limits. To learn more about your state’s requirements, check your jurisdiction’s laws or talk to a lawyer.
Interest and IRS rules
A Promissory Note can charge interest or not. An interest-bearing note includes a rate, and the borrower repays the principal plus interest. For example, a $5,000 loan at 5% simple interest per year accrues $250 in interest after one year, for a total of $5,250.
A non-interest-bearing note only requires the borrower to repay the principal. In the same example, the borrower repays exactly $5,000.
For private loans, the IRS publishes monthly applicable federal rates. Lenders who charge interest below these rates may face tax consequences, though small loans are often exempt.
The IRS covers related rules on below-market loans in Publication 550. Many states also cap how much interest a lender can charge.
What can make a Promissory Note invalid?
A Promissory Note may be unenforceable, in whole or in part, if it’s incomplete or its terms conflict with state or federal laws. Some issues can also make a note voidable, which means one party may choose to cancel it.
Examples include:
- The document is missing required signatures.
- The interest rate exceeds state limits.
- The note has ambiguous or unfair terms.
- The loan is for an illegal purpose.
- Someone made unauthorized alterations to the document.
- The party seeking to enforce it can’t prove its existence or original terms.
A note may also be voidable if a party was misled into signing it through fraud or misrepresentation, or if a party lacked the legal capacity to enter the contract.
LawDepot’s customizable Promissory Note helps you create a note based on your state’s general requirements. Laws vary and can change, and a lawyer can answer questions about a specific note.
How to write a Promissory Note
Yes, you can write your own Promissory Note, as long as it includes the key elements and follows your state’s rules.
LawDepot’s customizable template walks you through it. First, select whether you’re lending or borrowing money. Then follow these steps to complete, download, and save your Promissory Note as a PDF.
Step 1: Document the loan details
Start with the basics of the loan:
- Purpose: Choose business, debts or bills, real estate, vehicle, or other.
- State: Choose the state whose laws will apply. The note is customized for that state.
- Loan amount: Enter how much is being lent.
- Interest: Select whether the lender will charge interest and, if so, enter the rate.
- Loan date: Enter the date the borrower will receive the money.
Step 2: Outline the payments
Next, add the loan’s payment details. Start with how the borrower will repay the loan: regular payments, a single payment, or another method. For regular payments, add how often the borrower will pay (monthly, weekly, or yearly).
Then add the first payment date and the payment schedule. A schedule can use a final payment date or a set number of payments. You can also state whether the borrower can make lump-sum payments or repay the loan early.
Finally, add details for late payments. This can be a late fee or an interest rate increase, as permitted by your state’s laws.
Step 3: Identify both parties
Include each party’s full name and address. A lender or borrower can be an individual or a company. For a company, include the full legal corporate name and address. You can also add multiple lenders or borrowers.
If anyone is co-signing the loan, their name and address must also be in the note.
Step 4: Add the final details
If the loan is secured, describe the collateral that backs the loan. Collateral should be personal assets or property, not real estate or land.
Then add any other information that’s relevant to the loan. For example, include requirements for early repayment, like a prepayment fee or a certain number of months’ worth of interest.
Finally, add the signing details, including whether a witness will be present when everyone signs.
Promissory Note FAQs
