What Is a Written Promissory Note?
A promissory note, or a note payable, is a legally binding document used by the borrower when loaning money to make a promise of repayment to the lender. The promise of repayment is typically during a fixed time or date or on demand.
In general, promissory notes are used to govern the transaction between a lender and a borrower. They set the terms and conditions of the transaction.
Types of Promissory Notes
The types of promissory notes often reflect the type of loans that they are written for. Some common types of promissory notes are discussed below:
- Simple Promissory Note: A simple promissory note is a written guarantee that money borrowed will be returned to the lender in an agreed-upon way. It does not detail the purpose of the loan.
- Student Loan Promissory Note: A student loan promissory note, or a master promissory note from the government, is an agreement that a borrower will repay their student loans with the interest charged. Most student loan promissory notes are between a borrower and the government but students may also create promissory notes with their parents or relatives who provide funding for their education.
- Real Estate Promissory Note: In a real estate promissory note, the borrower uses their property as collateral. If the borrower defaults, the lender can place a lien on the collateral. This makes the information public record and impacts the borrower’s credit.
- Personal Loan Promissory Notes: A personal promissory note is used to record a loan between friends or family members.
- Car Promissory Note: A car promissory note is used during the sale or exchange of a car. It creates an agreement that the borrower will make payments to the lender in exchange for a car. Other vehicles also follow the same process of producing a vehicle promissory note to record loans.
- Commercial Promissory note: A commercial promissory note is used when money is borrowed from a commercial lender such as a bank or loan agency. If the borrower defaults or is unable to make timely payments, the lender can demand full payment of the loan with interest. The lender is also entitled to place a lien on assets owned by the borrower till the lender has received all repayments.
- Investment Promissory Note: An investment promissory note, often used in place of a business loan, is used to raise capital for businesses. They ensure that the investor receives a return on their investment over a given period of time. This reduces the risk of investing in a business. If the borrower fails to pay, the investor is entitled to take ownership of the company.
Promissory notes can also differ based on the type of payment they use:
- Installment Payment: An installment payment promissory note is generally used when purchasing expensive items. Payments are sent in installments or divided up in batches.
- Installment Payments with a Final Balloon Payment: These are used mostly in mortgage loans. The borrower pays small installments before paying a large sum of repayment back in one go.
- Due on a Specific Date : Due on a specific date (DOSD) promissory notes require the repayment of a loan or debt before a certain date
- Due on Demand or Default: A due on demand or default promissory note is a pay when you can type of note mostly used between family and friends for small loans.
Here is more on types of promissory notes.
How To Write a Promissory Note – Step by Step
You can write your own promissory note by following some easy steps below:
- Date : You should include the date on which the promissory note was created at the top of the page.
- Amount : Always include the amount of money being borrowed. This avoids any future disagreement and alteration.
- Loan terms : The note should also include the terms of the loan. The loan terms explain how the loan will be paid back, when and the method of repayment. It includes specific dates and timelines.
- Interest rate . You should mention the rate of interest on the loan. This section should mention if the loan is fixed or variable.
- Loans are often backed by a collateral in case the borrower defaults. A collateral provides security for the lender. Often providing a collateral lowers the interest rate on loans. These are known as secured loans. If the loan is secured by collateral, the promissory note should provide details about the collateral and its value.
- Default terms: The promissory note should also mention the terms of default.
- Lender and borrower information. This section covers the information about all parties involved in a loan. It describes the lender and the borrower along with their addresses and contact information.
- Signatures : All parties must sign the note for it to be legally enforceable. Generally promissory notes only need to be signed by the borrower that is making the promise.
- Release of Promissory Note : Once the loan is paid back, the commitment of the parties in the promissory note can also be brought to an end. For this you will need to issue the release of the promissory note.
Here is more on elements of promissory notes.
How Do Promissory Notes Work?
A promissory note is a promise to pay back a loan but is different from a loan agreement or mortgage note . While all three record a loan, the loan agreement provides a more detailed account of the loan transaction. A loan agreement contains important information and clauses dictating repayments, disputes, etc. Both the lender and the borrower need to sign the loan agreement. A promissory note is simply a formal promise that the borrower will repay the loan. It only needs to be signed by the borrower.
Examples of When To Use a Promissory Note
A promissory note can be used in the following events:
- Student Loans: If you are borrowing money for educational purposes, you can use a student loan promissory note to signify that you will be repaying your student loans.
- Car Loans : If you are buying a vehicle, such as a car, you can use a car promissory note to ensure the lender that you will be paying back the car loan under the set terms.
- Business Loans: If you are borrowing money to invest in your business or to start a business, you can use a business promissory note to ensure the lender that you will be paying back the loan under the set terms and timeline.
- Personal Loans : If you are borrowing money from family and friends, you can use a personal promissory note to promise repayment under set terms.
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