Promissory notes are of great importance among lenders to evidence their loans. Lenders have been relying on them long before the arrival of credit agreements. The promissory note indicates that an individual is obliged to repay a specific amount of loan at a specified date.
Alternatively, promissory notes can be used to document the terms in case finance is needed by you, or you are asked to lend money to others on a long-term basis. To know more about the promissory note, scroll down and give it a read!
What Is a Promissory Note?
As the name suggests, ‘Promissory Note’ is referred to as the ‘promise to pay’. In this note, a specific amount of money that is borrowed from the lender is written along with its repayment structure.
The lender uses the promissory note to hold the borrower accountable to pay back the loan along with interest (if any). This note serves as a financial instrument as it entails a written promise by an issuer (lender) to pay another party (borrower) a fixed amount of money.
A promissory note can also serve as a standalone document between you and another individual or any business. This legally binding document indicates a promise of payment. This can be used for both personal as well as business loans.
Types of Promissory Notes
Generally, there are 2 main types of promissory notes, namely, secured and unsecured.
Secured Promissory Note
A secured promissory note refers to the legal document that enables the lender to lend money to a borrower with additional insurance. In the secured note, if the borrower fails to pay back borrowed money, then the security (asset or property) is handed over to the lender.
In a secured note, there is less risk to the lender when lending money. Besides, it enables the borrower to pay comparatively a lesser interest rate. Since this note contains some form of collateral, it assures that the lender receives the value of their investment.
Unsecured Promissory Note
Unsecured note, in contrast, does not enable the lender to secure any property or asset for their money loaned. Simply put, if the borrower did not make a payment, the lender would have to file a small claims court.
An unsecured promissory note does not contain any property or asset as collateral in case the borrowed money goes unpaid. Moreover, the payment structure in the unsecured note is based on either a weekly or monthly basis.
When and Why a Promissory Note is Needed?
Promissory notes can be used for various loans such as student loan, business loan, car loan, mortgages, as well as personal loans between friends and family. This legal document serves as an IOU (I Owe You) agreement.
This note is needed whenever you have to lend a large sum of money either to a person or business. The promissory note will serve as a legal record of the money loaned while protecting you (lender) and ensuring that the borrower will repay your money.
Either party (lender or borrower) can create the promissory note. However, lenders are advised to create this note to protect assets by adding provisions in a note for any default from the borrower's side.
What Is Included in a Promissory Note?
Promissory notes include the following information along with other terms and conditions:
- Names of lender and borrower
- Addresses of both lender and borrower
- Amount of money borrowed or collateral used (if any)
- The maximum length of the loan period
- How often payments will be made and the amount of payment
- Interest rate (if charged)
- Secured or unsecured note
- Signatures of both parties and witnesses
All in all, promissory notes are used as a do-it-yourself agreement when lending money. With this legally binding IOU, a lender can hold the borrower accountable to pay back the loan on time.
Now that you have comprehensive knowledge about the promissory note, you can avail of various templates for a note on our website CocoSign.
Promissory Note FAQs
Are promissory note and loan agreement different?
Both agreements are used to evidence that the borrower owes a specific debt to the lender. However, in the loan agreement, more extensive clauses are included as compared to the promissory note. Moreover, in a promissory note, the borrower’s signs are more important, whereas both parties must sign a loan agreement.
Should promissory note be witnessed?
No, there is no need for a witness or notary public to sign a promissory note.
Is it necessary to charge borrowers interest?
No, it depends on the lender whether he/she wants to charge interest or not. In case lenders charge interest, it is up to them how much interest they want to charge.
Should lenders require collateral/security for promissory note?
It is totally up to the lender. If the lender does not take collateral/security and the borrower defaults on a promissory note, he/she will need to take the borrower to court to recover loaned money. In contrast, if the lender takes collateral, then he/she is authorized to seize or sell the collateral in case the borrower fails to make repayment.
Should collateral be equal in value to money loaned?
No, collateral for promissory notes can be of any amount. In case the borrower is unable to repay the promissory note while the worth of collateral is less than the actual loan payment, the lender is entitled to seize collateral. Also, the lender can sue the borrower to get the remaining loan amount.