What Does It Mean to Draft a Promissory Note?
Drafting a promissory note means creating a legally enforceable written promise to repay a loan on a future date.
A promissory note is less formal than a loan agreement, so it has fewer terms and conditions. However, it is still a legally binding obligation to repay the debt to someone with a fixed or determinable amount of interest.
By repaying debt with a promissory note, you can repay what you borrow in smaller sums of money versus a lump sum. This makes it easier to return funds to someone without having all the cash upfront.
It’s helpful to think of a promissory note as the middle ground between an IOU and a formal loan agreement.
Here is an article that defines promissory notes.
Who Can Use a Promissory Note?
Anyone borrowing money from someone can use a promissory note to promise to repay their debt in the future. A promissory note legally binds the borrower to the lender, whether the lender is an individual or a company. Promissory notes can be used when borrowing a mortgage, taking out an auto loan, a student loan, or a personal loan.
Signing a promissory note is often the last step of the loan borrowing process. The lender will request the borrower to sign the note to solidify their agreement to repay their entire debt plus interest later.
The most significant difference between an IOU and a promissory note is that a promissory note contains similar elements to a formal loan agreement. These elements include:
- The total amount of debt owed plus interest
- The timeline
- The terms of the repayment agreement
An IOU simply confirms that someone has a debt, but there is no legally enforceable timeframe for repayment.
Although a promissory note can be used in formal situations, it is not as common when borrowing large sums of money as a legal loan agreement. However, you may use a promissory note instead of an IOU if you were personally lending money to a friend or family member.
Here is an article about promissory notes vs. loan agreements.
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What Should Be Included in a Promissory Note?
At the minimum, a promissory note should include the following:
- The borrower and lender the names
- The amount of money being borrowed
- The interest rate
- The agreed-upon terms of repayment
A promissory note should also include the date the loan is dispersed and a timetable for repayment. There should also be a final date of payment, where all owed debt plus accrued interest is due to the lender.
Below are some other features that you made include in a promissory note:
- Penalties for late payment
- Any collateral that the borrower has offered
- Mutually agreed-upon payment methods
- Consequences of defaulting on the loan
The details included in your promissory note depend on what kind of loan you're borrowing. For example, if you take out a mortgage and sign a promissory note from your lender, they will have a lien against your house until you pay off the mortgage.
On the other hand, if you simply borrow a lump sum from a friend or relative for personal reasons, they may not include full details about why you borrowed the money. The promissory note, in this case, simply assures them that you will repay the debt you owe in the future.
The most important element to include in any promissory note is the date by which the borrower must fully repay their debt. Without any date, it will be difficult for a court to legally enforce anyone to pay the money within a certain timeframe.
Here is an article by RocketHQ to read more about different types of promissory notes.
How Do You Draft a Promissory Note?
Promissory notes have different legalities depending on the state you live in. However, all promissory notes must include an unconditional promise to repay debt, due dates and payment methods, and a total amount owed, including the principal balance of the loan and any interest.
A lawyer can also help you draft a legally binding promissory note. Working with an attorney is one of the best ways to ensure that your promissory note contains all the necessary elements and provides the greatest level of legal security.
Here is an article by ContractsCounsel with eight easy steps to follow when writing a promissory note.
Is a Promissory Note a Loan?
No, a promissory note is not a loan or a loan agreement. A loan agreement is a more formal contract between borrowers and lenders, and they have more terms and conditions and legal consequences than a promissory note.
Loan agreements are more comprehensive and often used when people borrow larger sums of money. Unsecured loan agreements do not allow the lender to seize any of your assets if you default on payment secured loan agreement; secured loans will enable the lender to seize collateral or assets they have a lien against in the event of non-payment.
Promissory notes between friends and family offer security that the borrower will repay their debt at a certain date. However, they still require an interest rate and deadlines for repayment.
Here is an article that explains when to use a promissory note.
What Makes a Promissory Note Invalid?
Like any legal document, promissory notes can also be invalidated under certain conditions. Below are the five most common reasons why promissory notes are deemed invalid in court.
Make sure you take steps to avoid any of these mistakes when drafting your promissory note.
- Incomplete signatures. Any legally binding contract or agreement must have signatures from both parties. You must use your legal names and ensure that the signatures are complete and legible.
- Missing dates. The primary purpose of a promissory note is to ensure a lender receives the money they loaned the borrower by a set date. Without any due days or deadlines for repayment, a promissory note is, at most, an IOU.
- No interest rates. Even personal loans require a minimum interest rate. Without any interest, the money loaned may not be considered a legal loan under your state laws—section 7872 of the Internal Revenue Code gift loans under $10,000 between individuals from minimum interest rates. If used for business purposes, they must pay interest.
- No original copy. You may make changes to your promissory note over the loan term. In that case, you will need a copy of the original version of the note. Amended versions of legal documents are generally only considered valid if there is an original copy to compare them to.
- Unreasonable terms. You cannot enforce unrealistic or exploitative terms on the other party. Legal consultation with a promissory note attorney can help you determine what is reasonable or unreasonable to include in a promissory note.
Learn how to write a promissory note from ContractsCounsel in nine easy steps.
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