Promissory Note: Definition, When To Use, What's Included
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What Is a Promissory Note?
A promissory note is a written promise to pay within a specific time period. This type of document enforces a borrower's promise to pay back a lender by a specified period of time, and both parties must sign the document.
A promissory note is not the same as a contract. A contract details all the terms of a legal agreement. A promissory note typically covers the following elements:
- The date by when someone needs to be paid
- How a person or organization needs to be paid
- How much a person or organization needs to be paid
Promissory Note Templates
Promissory notes are common documents in any financial service. You've likely signed one if you have taken out any type of loan in the past.
You may also encounter a promissory note referred to as:
- Commercial paper
- Demand note
- IOU
- Loan agreement
- Notes payable
A promissory note establishes a clear record of a loan, either between individuals or between entities. By placing all relevant details in writing, a promissory note ensures clarity on due dates for payments and the amount of payments.
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When Should I Use a Promissory Note?
A promissory note is commonly used for the following transactions:
- Business loans
- Car loans
- Mortgages
- Personal loans among friends or family
- Student loans
If you are lending a person or a business money, you may want to formalize the loan by creating a promissory note. A promissory note is especially important if you are lending a large amount of money. The promissory note functions as a legal record of your loan, helping to protect you and to ensure that a person or organization repays you.
Common types of promissory notes include the following:
- Commercial: These notes are more formal and detail specific conditions of a loan.
- Investment: A company can decide to issue a promissory note to raise capital. The company can also sell these notes to other investors.
- Personal or informal: These notes generally involve one family member or friend loaning a sum of money to another family member or friend.
- Real estate: These notes accompany a home loan or other real estate purchase.
What Should I Include in a Promissory Note?
A promissory note should include all terms and details to which both parties of a loan are agreeing. Since every state has its own laws governing the essential components of a promissory note, you'll want to verify the laws of your state. State-specific laws can greatly impact the enforceability and terms of a promissory note.
Important details any promissory note should state include the following:
- Payor or borrower: Include the name of the party who promised to repay the stated debt
- Payee or lender: Include the name of the lender, the person or entity, lending the money
- Date: List the exact date the promise to repay is effective
- Amount or principal: State the face amount of the money borrowed
- Interest rate: If the loan involves interest, the promissory note should include the interest rate charged. The interest rate may be simple or compounded. There are usury laws in many jurisdictions that limit the amount of interest a lender can charge for a loan.
- Date first payment is due: A common arrangement is to have the first payment due on the first day of the month and subsequent payments due on the first date of the following months.
- Details of each payment: If multiple payments are due, the promissory note should include how often payments will be made as well as the amount of each payment.
- Date the promissory note ends: In the case of an amortized loan, a loan paid off in a series of even and equal payments on a specified date, the date the note ends could be the last payment. An agreement could also involve a balloon payment, specifying a date on which the entire unpaid balance is due.
- Signatures: Make sure signatures of both the borrower and the lender are included on the promissory note. For most jurisdictions, a promissory note needs signatures to be legally enforceable. It is worth noting that some jurisdictions may enforce a promissory note even if only signed by the borrower, provided other conditions are met.
Types of Promissory Notes
Different types of promissory notes are appropriate for different types of agreements. You should create your promissory note to fit the type of transaction in which you're involved. Promissory notes can be as simple as a one-time payment from a friend. Transactions such as car loans and mortgages require more complex promissory notes that cover details such as amortization schedules, interest rates, and more.
Types of promissory notes include the following:
- Simple promissory note
- Demand promissory note
- Secured promissory note
- Unsecured promissory note
Simple Promissory Note
If you're writing a promissory note for a lump sum repayment, you'll typically use a simple promissory note. An example is lending your sibling $2,000. Your sibling agrees to pay you money back by January 1. A simple promissory note will state the full amount is due on the stated date; you won't need a payment schedule. You can decide whether to charge interest on the loan amount and include the interest in the document if needed.
Demand Promissory Note
A demand promissory note makes payment due when the lender asks for the money back. You will typically need to provide a reasonable amount of notice to use this type of promissory note.
Secured Promissory Note
A secured promissory note secures the amount loaned with an asset of value, for example, a home or vehicle. If the borrower does not pay back the loan amount within the agreed-upon time frame, the lender has the right to seize property of the borrower. This often involves a legal process the lender needs to go through in order to seize the property.
For example, when you buy a house, the house is collateral on your mortgage. Your bank can seize your home if you do not make stipulated payments by way of a legal process.
Unsecured Promissory Note
This type of promissory note does not allow the party lending the money to secure an asset for the loan. If the borrower does not make the payment, the lender must instead file in small claims court or go through other legal processes to enforce the note.
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What Happens When a Promissory Note Is Not Paid?
Promissory notes are legally binding documents. Someone who fails to repay a loan detailed in a promissory note can lose an asset that secures the loan, such as a home, or face other actions.
You have a few options if someone who has borrowed money from you does not pay you back. First, you should ask for the repayment in writing. A written reminder might be all you need to do to get your money paid back. Past due notices are commonly sent at 30, 60, and 90 days after the stated due date.
If the borrower still does not pay you back, you might consider asking your borrower to make a partial payment. You can create a debt settlement agreement if you decide to accept partial repayment of a debt. You may also consider creating an extended payment plan that allows the borrower to pay you back in full over a revised period of time.
You can also choose to use a debt collector to obtain repayment. A debt collector works with you to collect the note, generally taking a percentage of the payment. Alternately, you can sell the note to a debt collector. Selling a note to a debt collector gives the debt collector ownership of the loan and the ability to collect the full amount. It is more common to assign debt to a debt collector, though.
If nothing else works, you can also sue your borrower for the full amount owed to you.
When writing a promissory note, make sure to include all important details to protect yourself. Get in touch with an experienced lawyer for help drafting your document.
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Nicholas M.
Nicholas Matlach is a cybersecurity expert (CISSP) and an attorney who is dedicated to helping small businesses succeed. He is a client-focused professional who has a deep understanding of the challenges that small businesses face in the digital age. He also provides legal counsel to small businesses on a variety of issues, including formation, intellectual property, contracts, and employment law.
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Anand is an entrepreneur and attorney with a wide-ranging background. In his legal capacity, Anand has represented parties in (i) commercial finance, (ii) corporate, and (iii) real estate matters throughout the country, including New Jersey, Pennsylvania, Delaware, Arizona, and Georgia. He is well-versed in business formation and management, reviewing and negotiating contracts, advising clients on financing strategy, and various other arenas in which individuals and businesses commonly find themselves. As an entrepreneur, Anand is involved in the hospitality industry and commercial real estate. His approach to the legal practice is to treat clients fairly and provide the highest quality representation possible. Anand received his law degree from Rutgers University School of Law in 2013 and his Bachelor of Business Administration from Pace University, Lubin School of Business in 2007.
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Attorney Steven Wax is ardent about helping his clients. Whether creating personalized estate plans, drafting and negotiating contracts or other legal matters. Steven’s goal is to assist and counsel his clients to protect them and their loved ones. Steven grew up on Long Island, New York. He attended the University of Massachusetts in Amherst earning a BS in Sport Management. He earned his paralegal certificate at Duke University and earned his Juris Doctorate from North Carolina Central University School of Law in Durham, NC. Steven has an extensive legal career in the life science sector, working for some of the world’s largest Contract Research Organizations since 2013. Steven has negotiated a broad range of contracts for both businesses and individuals. Steven participated in the NCCU Elder Law Project, where he prepared wills, durable powers of attorney, living wills, and health care powers of attorneys for low/fixed income clients in Durham and surrounding counties. Steven finds meaningful ways to share his skills and passion with his community. Steven volunteers his time to Wills for Heroes, which provides no-cost estate planning documents to first responders and their families, through the NC Bar Foundation.
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Debt
Promissory Note
Illinois
Can you do a promissory note for my tenant?
my tenant owes me $10,400 back rent, she promises to pay me back.
T. Phillip B.
Yes, you could create a promissory note and terms in that note for repayment of back rent. That would create an obligation for her that if she defaults, you'd file as a breach of contract rather than an eviction at that point.
Business
Promissory Note
California
What happens to convertible note if startup fails?
I have a startup and am looking to raise money from investors. If we fail, are we going to be liable for anything if we raise money on a convertible note?
Michael M.
Typically, if the business fails, the note can then not be converted or repaid. Unless you have personally guaranteed the obligation which would be unusual, the recourse would be against the entity itself.
Financial
Promissory Note
California
When to use a promissory note?
I recently started a small business and am in need of a loan to expand operations. I am researching the different types of financing available to me and came across promissory notes. I am unfamiliar with the process and need guidance on when a promissory note is appropriate for my loan.
Russell M.
I'd be happy to explain what a promissory note is and provide context regarding its use in financing a business, as well as alternatives. A promissory note is a legal document that outlines a borrower's promise to repay a specific amount of money to a lender within a defined period of time. It serves as evidence of a debt and includes details such as the principal amount, interest rate, repayment terms, maturity date, and any additional terms and conditions agreed upon by both parties. Promissory notes are commonly used in business financing to secure loans from individuals, financial institutions, or even other businesses. They are a formal way to document the terms of a loan and provide legal protection to both the borrower and lender. In the context of financing a small business, promissory notes can be a suitable option when: 1. Borrowing from family and friends: If you're seeking funding from personal contacts, a promissory note can formalize the agreement, clarify repayment terms, and protect relationships. 2. Seeking private financing: Promissory notes can be used to secure loans from private investors or other businesses. They offer flexibility in negotiating terms, allowing you to tailor the agreement to your specific needs. 3. Exploring alternative lending options: In some cases, small businesses may face challenges obtaining loans from traditional financial institutions. Promissory notes can be an alternative financing method that appeals to investors looking for higher returns or businesses with unique circumstances. However, it's essential to consider alternative financing options alongside promissory notes. Here are a few alternatives to keep in mind: 1. Bank loans: Traditional bank loans often offer favorable interest rates and longer repayment terms. They may require more documentation and have stricter qualification criteria, but they can be an attractive option for businesses with a solid credit history and established operations. 2. Small Business Administration (SBA) loans: The SBA provides government-backed loans to small businesses. These loans typically offer competitive terms, including longer repayment periods and lower down payments, but they often involve more paperwork and longer approval processes. 3. Equity financing: Instead of borrowing money, some businesses opt to sell equity in their company in exchange for funding. This approach involves giving up a portion of ownership but can provide access to larger amounts of capital and potentially benefit from the expertise of investors. 4. Crowdfunding: Crowdfunding platforms allow businesses to raise funds from a large number of individuals, often in exchange for rewards or equity. It can be a viable option for startups or businesses with unique products or ideas. When considering financing options, it's crucial to assess factors such as the cost of borrowing, repayment terms, the impact on ownership, and the specific needs and goals of the business. Working with a financial advisor can help you evaluate the pros and cons of each option and determine the most suitable approach for your business's financing needs. For more, you can check out this excellent overview on Investopedia: https://www.investopedia.com/terms/p/promissorynote.asp
Dispute
Promissory Note
New York
Breach of contract: Promissory note
Someone owe my money which he took as a loan signing a promissory note. He moved out of Syracuse, NY and know that he is living in the state of Ohio. How can I sue him to collect $7,286? Please help.
Donya G.
Does your promissory note talk about what happens if he doesn't pay? Does the law of NY apply to your agreement? If so, you can sue in NY court. In order to get a firm answer on what to do, I would need to review the promissory note and see what it says. You can connect with me and engage my services through Contracts Counsel. Donya Gordon
Consumer
Promissory Note
Connecticut
Promissory note termination options?
I recently signed a promissory note with a lender for a loan. I am now concerned that I may not be able to make the payments and am looking for options to terminate the promissory note if necessary. I need to know what my options are, as well as any potential consequences, regarding terminating the promissory note.
Thomas L.
Contact the lender and request a resolution of your loan, that is, some terminating reduction. The lender is under no duty to assist you, and can sue you for the unpaid balance, get a judgment and then seize your property (bank accounts, cars, etc) to get the note repaid.
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