A promissory note is a financial tool used to put the terms of a loan in writing. The note spells out the amount borrowed by one party, as well as how and when the money will be paid back. A promissory note is a legal contract that binds the borrower by law. If the borrower fails to repay the money according to the terms of the note, the lender may file a civil lawsuit to obtain a judgment, and possibly take additional action, to get his money back. To explore this concept, consider the following promissory note definition.
Definition of Promissory Note
- A written promise to pay a specified amount of money to a specific person, by a specified date.
What is a Promissory Note
A promissory note is a written and signed contract in which one party promises to pay a specified amount of money to the other party. The terms of a promissory can be tailored to the parties’ needs, as far as the amount borrowed, whether interest will be charged, the schedule or date by which the money must be repaid, and any other needed particulars.
There is no requirement that a promissory note be made on a certain type of paper or document, or that it contain complex language, though it is important to be as specific as possible. In fact, a promissory written and signed on a scrap piece of paper, back of a napkin, or even in an email or text message, is just as valid as a note drawn up by a lawyer.
Informal Promissory Note Example
Mike and John are having a beer at the local pub after work when John mentioned he needed to come up with $1,000 to send to his ex-wife by the end of the week, or he would be in trouble with the family court judge. Mike offered to lend John the money, if John could repay it by the 15th of the following month. John agreed, and Mike grabbed a cardboard drink coaster, and borrowed a pen from a waitress. He wrote the following on the coaster:
“I, John Smith, borrowed $1,000 Mike Brown, and promise to repay the entire amount by March 15, 2015.”
He had John sign the coaster and stuck it in his pocket. When John had not repaid the money by July, and avoided making a commitment to a payment arrangement, Mike filed a civil lawsuit. At the small claims court trial, Mike gives the promissory note drink coaster, with John’s signature on it, to the judge. The judge rules that the coaster is a valid contract, and that John must repay Mike the entire amount of the loan immediately.
Types of Promissory Note
Though every good promissory note contains certain elements, there are several types of promissory note. These notes are largely classified by the type of loan issued, or purpose for the loan. All of the following types of promissory note are legally binding contracts.
Personal Promissory Note
This type is used to record a personal loan made between two parties. While not all lenders use legal writings when dealing with friends and family, it helps avoid confusion and hurt feelings later. A personal promissory note shows good faith on behalf of the borrower, and provides the lender with recourse should the borrower fail to pay back the loan.
Commercial Promissory Note
A commercial promissory note is typically required with commercial lenders. Commercial promissory notes are often more strict than personal notes. If the borrower defaults on its loan, the commercial lender is entitled to immediate payment of the full balance, not just the past due amount. In most cases, the lender on a commercial promissory note can place a lien on the borrower’s property until payment in full is received.
Real Estate Promissory Note
A real estate promissory note is similar to a commercial note, as it often stipulates that a lien can be placed on the borrower’s home or other property if he defaults. If the borrower does default on a real estate loan, the information can become public record.
Investment Promissory Notes
An investment promissory note is often used in a business transaction. Investment promissory notes are exchanged to raise capital for the business, and they often contain clauses that deal with returns on investments for specific periods of time.
Differences Between a Promissory Note, a Loan Agreement, and an IOU
When someone borrows money, or makes a purchase without paying for it up front, there are many ways to document that repayment is expected. While all three contracts spell out such terms, there are certain differences between a promissory note, a loan agreement, and an IOU.
|Includes Timeline for Repayment|
|Specifies Interest Rate|
|Requires Repayment in Installments|
|Specifies Rigid Consequences for Non-Payment|
Promissory Note Payment Options
While promissory notes may be used in certain formal loans, they are commonly seen when friends, family, or acquaintances loan one another money. Because each of these situations is different, the parties are free to write their loan agreement in any manner they choose.
This includes using a variety of promissory note payment options to suit the needs of both parties. Promissory note payment options include the structure of the loan, repayment terms, and other information vital to enforcing the note. In addition to the amount of the loan, it is important to include very specific terms for repayment. Types of repayment include:
A lump sum payment option is the most straightforward type of repayment, as it specifies that the borrower will repay the entire amount of the loan with a single payment. A date is specified in the note, on which the full repayment is due, including interest if applicable.
Due on Demand
A due on demand note specifies that the borrower must repay the loan when the lender asks for it. The borrower is given a reasonable amount of time before such a demand may be made. In some cases, the lender is given the option of asking for payments before demanding the balance in full.
A lender can structure the promissory note with interest to calculate a monthly or annual interest rate, based on the amount remaining on the principal loan. When the borrower makes payments, the payment is applied to the accrued interest first, then the balance of the payment is applied to the principal.
Sample Promissory Note
Promissory notes may vary greatly in their wording. While it is acceptable for the parties to “wing it,” so to speak, there are sample promissory notes available from a variety of sources. When creating a promissory note, it is important for both parties to be sure each detail of the transaction is clearly stated in the contract. In addition, the borrower should read the contract carefully before signing. Promissory notes require only the signature of the borrower.
In order for a promissory note to be legally binding should a dispute arise, the language and provisions should be clearly understandable, as an ambiguous agreement may be deemed invalid by a court. The following sample promissory note may be used as a guide in creating an agreement.
Principal Amount: $_________
Borrower: ________________________, of _______________________________________ [address]
Lender: ________________________, of _______________________________________ [address]
1. FOR VALUE RECEIVED, Borrower promises to pay to Lender, at the address provided in writing to Borrower, the principal sum of $_______________, with interest payable on the unpaid principal balance at the rate of __________ percent per ________________[annum, or month] calculated ________________[monthly or yearly].
2. This Promissory Note will be repaid, including any interest accrued, on or before ___________________ [date].
3. Borrower may pay the outstanding balance of this note at any time, with no prepayment penalty, though any interest accrued to the date of repayment shall be due and payable. In the event Borrower is in default at the time of repayment, he shall remain liable for such penalties as may have been assessed through the date of repayment.
4. Should it be necessary for Lender to take legal action to enforce this Promissory Note, Borrower shall be responsible for paying all costs and expenses, including, Lender’s legal fees and costs, incurred in such enforcement. Costs of enforcement will be added to the outstanding principal balance, which shall become immediately due in full.
5. This Promissory Note shall be construed and governed by the laws of the state of _______________ [state in which the contract is made].
6. If any term or condition of this Promissory Note should be determined by a court of competent jurisdiction to be invalid or unenforceable, it is the parties’ intent that such term or condition be reduced in scope by the court only to the extent necessary to render the provision reasonable and enforceable, and that the remaining provisions of this Promissory Note will not be affected, invalidated, or impaired as a result.
Executed this ____ day of ____________ [month], ______ [year]
________________________________________ [signature of Borrower]
[Print or Type name of Borrower]
The sample promissory note above contains an agreement to repay the loan at the end of the term, with no periodic payments. If the parties wish for payments to be made by Borrower, the schedule of payments must be included in the Note.
Defaulting on a Promissory Note
A promissory note is a legally binding contract, the provisions of which usually spell out what acts, or failures to act, constitute a default. Failing to pay as agreed constitutes defaulting on a promissory note, as might any number of other deviations from the terms of the agreement. The note should also state specifically what will happen should the borrower default.
If the promissory note was secured by some type of personal or real property, defaulting on a promissory note is likely to result in the lender foreclosing on that property. If the property is not worth the amount due on the loan, the lender may file a lawsuit asking a judgement for the remaining balance. This is referred to as a “deficiency judgment.”
For an unsecured loan, the lender may file a civil lawsuit asking the court to order the borrower to pay the balance due immediately. In this situation, the borrower would also likely be ordered to pay the lender’s costs for collection attempts, court costs, and attorney’s fees. Even if the loan was not secured by something of value, the lender may place a lien on the borrower’s property.
A judgment by the court may result in the borrower’s wages and/or tax return being garnished, and the damage doesn’t end there. Defaulting on a promissory note can have a long-lasting effect on the borrower’s credit.
Is Defaulting on a Promissory Note a Crime
Defaulting on a promissory note is a civil matter, which is dealt with in civil court. If, however, the borrower falsified information on the loan application, or the note itself, it may be considered fraud, which is a crime.
Example of Promissory Note Effecting Jury Ruling
Eighty-year old Marion Levine lent money to her step-grandchildren from her third marriage, in 2000, having drawn up a promissory note which the grandchildren signed. The grandchildren paid on the note until 2005, when they suddenly stopped. Following Marion’s death in 2009, the executor of her estate realized that she had this outstanding loan.
The executor asked the borrowers to repay the debt, but they refused, claiming that Marion had forgiven the debt. Because there was no record of Marion having ever forgiven the debt, and she did carefully document the promissory note and payments received, her executor hired an attorney to enforce the note on behalf of the estate.
Having a signed personal promissory note had a definite effect on the outcome of the three-day trial. The judge ordered all of the borrowers to repay the remaining principal balance of the note, as well as legal fees expended to obtain the judgment.
Related Legal Terms and Issues
- Binding – Having power to bind or oblige; imposing an obligation.
- Civil Lawsuit – A lawsuit brought about in court when one person claims to have suffered a loss due to the actions of another person.
- Criminal Charge – A formal accusation by a prosecuting authority that an individual has committed a crime.
- Contract – An agreement between two or more parties in which a promise is made to do or provide something in return for a valuable benefit.
- Default – Failure to fulfill an obligation, or to appear in a court of law when summoned.
- Defendant – Control or advantage held by one entity over the commercial market in any specific geographical region.
- Jurisdiction – The legal authority to hear legal cases and make judgments; the geographical region of authority to enforce justice.
- Legally Binding – An agreement that is written and enforceable by law.
A simple promissory note might be for a lump sum repayment on a certain date. For example, you lend your friend $1,000 and he agrees to repay you by December 1. The full amount is due on that date, and there is no payment schedule involved.What are 3 things you can find on a promissory note? ›
A promissory note typically contains all the terms involved, such as the principal debt amount, interest rate, maturity date, payment schedule, the date and place of issuance, and the issuer's signature.Which is a valid example of promissory note? ›
An instrument to be valid Promissory note must have an undertaking to pay a sum. Thus the writing "I owe you Rs. 500", "I am liable to pay" or "I am bound to pay", constitutes only acknowledgements of liability to pay and cannot treated or dealt with us Promissory note. I promise to pay Rs.What is the meaning of promissory note? ›
A promissory note is a written promise to pay a sum of money, to a specified individual or organization, at a specified time in the future, and that is not always supported by a guarantee.What makes a valid promissory note? ›
A promissory note must include the date of the loan, the dollar amount, the names of both parties, the rate of interest, any collateral involved, and the timeline for repayment. When this document is signed by the borrower, it becomes a legally binding contract.What is the rule of promissory note? ›
An unconditional promise to pay a certain amount of money to a named party or the holder of the note, or to deposit that money as such persons direct. A promissory note must be in writing and signed by the maker of the promise. COMMERCE. business law. contracts.Do promissory notes hold up in court? ›
Promissory notes are legally binding contracts that can hold up in court if the terms of borrowing and repayment are signed and follow applicable laws.What makes a promissory note invalid? ›
A promissory note could become invalid if: It isn't signed by both parties. The note violates laws. One party tries to change the terms of the agreement without notifying the other party.Which is not an example of promissory note? ›
A mere acknowledgement of indebtedness without an express promise to pay the debt is not a promissory note. Examples: I have received Rs. 1000/ which I have borrowed from you, and I have to be accountable to you for the same with interest.How do you execute a promissory note? ›
The first step in enforcing an unsecured promissory note is to file a petition with the courts and get a judgment in your favor. Although this is a powerful legal enforcement of your rights under the promissory note, it does not in and of itself guarantee repayment of the note.
Is a promissory note a legal document? Yes, even if it's not written by a lawyer. If you sign the document, you're bound as the payer or payee to abide by the terms of the agreement.Can a promissory note have no interest? ›
If you decide to give the loan without charging any interest, be prepared to justify it to the IRS, because it literally is a gift in the IRS's eyes. The IRS can "impute" interest on your loan, whether you actually charged any interest or not, and require you to report that imputed interest as income.What is a basic promise to pay? ›
A promissory note is a written promise to pay back money owed within a specific timeframe. The borrower receives the funds after the note is signed and agrees to make payments under the terms and conditions of the note. The lender will collect interest which acts as a fee for lending the money.What is an example of a promissory note payable to order? ›
PROMISE OR ORDER TO PAY: There must be a written undertaking to pay money that is signed by the person promising to pay. For example, “I, John Smith, promise to pay to the order of Jan Smith two hundred dollars” would satisfy this requirement.How do you write a promise to pay agreement? ›
- 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.
While a promissory note involves two parties (the payer and the payee), checks involve three parties (the payer, the payee, and the bank from which the funds are drawn).What are five characteristics of promissory note? ›
A promissory note consists of various terms and conditions which are related to the indebtedness such as principal amount to be paid, date of maturity, rate of interest on amount to be paid, terms and instructions of repayment, issuing date, name along with the signature of the drawer, name of the drawee and many more.What elements are required for the promissory? ›
The three main components needed for promissory estoppel are the promisor, the promisee, and the promise that wasn't honored. The injustice happens when the promisee suffers a loss when he relied on the promise, and the promise wasn't kept.What is a breach of promissory note? ›
A promissory note is breached when payment due, or properly demanded as per the terms of the note, is not received. If you want to enforce a breached promissory note, you must follow the terms agreed upon when making demands for payment.What happens if you breach a promissory note? ›
A promissory note may include a default on secured debt as part of the agreement. This means that if the borrower fails to pay under the agreed-upon terms of the promissory note, then the lender can take the secured debt as a form of payment.
Secured promissory notes
This means that if the payor fails to pay, the payee can seize the designated property to obtain reimbursement of the loan. By assuring that the property attached to the note is of sufficient value to cover the amount of the loan, the payee thus has a guarantee of being repaid.
All Promissory Notes are valid only for a period of 3 years starting from the date of execution, after which they will be invalid. There is no maximum limit in terms of the amount which can be lent or borrowed. The issuer / lender of the funds is normally the one who will hold the Promissory Note.Can you back out of a promissory note? ›
The debt owed on a promissory note either can be paid off, or the noteholder can forgive the debt even if it has not been fully paid. In either case, a release of promissory note needs to be signed by the noteholder.What are promissory conditions? ›
A promissory condition is a promise whose performance either suspends a duty of immediate performance until it occurs or gives rise to such duty upon its occurrence. A, non- promissory condition creates a privilege in the case of a condition precedent and a power in the case of a condition subsequent.Who is primarily liable on a promissory note? ›
Only makers and acceptors (drawees that promise to pay when the instrument is presented) are subject to primary liability. The maker of a promissory note promises to pay the note. An acceptor is a drawee that promises to pay an instrument when it is presented later for payment.Which of the following statements are true for a promissory note? ›
A promissory note is a legal, financial instrument in which one party promises another to pay a debt on a specific date. It's a formal agreement signed by the drawer promising to pay the money on a certain date or whenever it's requested.Does a promissory note need to be notarized? ›
Promissory notes don't have to be notarized in most cases. You can typically sign a legally binding promissory note that contains unconditional pledges to pay a certain sum of money. However, you can strengthen the legality of a valid promissory note by having it notarized.What is better than a promissory note? ›
It is more difficult to recover repayment through a promise alone than if there is collateral involved and described in the promissory note. Loan agreements tend to afford greater safety for both the lender and borrower.How do you get money owed on a promissory note? ›
To collect on a demand promissory note, you will need to send a demand for payment letter to the lender. This lets the lender know that you want the loan paid back now and that the repayment period is ending. This demand letter should include the following: The date of the letter.Can anyone write a promissory note? ›
If you're borrowing or lending money, you should consider having one—you can write one either as the borrower or the lender.
Who holds the promissory note while it's being repaid? The lender is the obligee who holds the note while it's being repaid. If the note is transferred, the new owner becomes the obligee and note holder.Do you pay taxes on promissory note? ›
Usually, income from a promissory note comes in the form of interest, which is subject to taxation and needs to be reported on your tax return. If you loaned your personal money, make sure to report the generated income on your individual tax return.Can you write your own promissory note? ›
You can use a template or create a promissory note online. But before you begin, you'll need to gather some information and make decisions about the way the loan will be structured. First, you'll need the names and addresses of both the lender (or "payee") and the borrower.What happens if a promissory note is not paid? ›
The promissory note should set out any interest or late fees that apply. If the borrower does not pay in full, the lender has a right to file a lawsuit for the outstanding balance. In some cases, the lender may also have the option to send the debt to a debt collection agency.Do promissory notes need to be notarized? ›
Promissory notes don't have to be notarized in most cases. You can typically sign a legally binding promissory note that contains unconditional pledges to pay a certain sum of money. However, you can strengthen the legality of a valid promissory note by having it notarized.What is required for a promissory note to be valid? ›
A promissory note must include the date of the loan, the dollar amount, the names of both parties, the rate of interest, any collateral involved, and the timeline for repayment. When this document is signed by the borrower, it becomes a legally binding contract.Can I sue with a promissory note? ›
Promissory notes state the amount of money borrowed, the name of the borrower, the name of the lender, the addresses of the parties, and so on. The lender may file a civil lawsuit to get the money back if the borrower fails to pay it back when due in accordance with the terms of the note.How do you legally enforce a promissory note? ›
Enforcing a secured promissory note is simply a matter of either repossessing the secured asset through your own efforts, or hiring a professional agency to accomplish the task on your behalf. These agencies will charge a set fee for their services, but they usually have a very high rate of success.Who executes a promissory note? ›
Haman, Esq. Once the debt of a promissory note has been satisfied, a release of promissory note should be executed by the holder of the note. Such a document serves as the borrower's proof that the debt has been paid.Who can issue a promissory note? ›
Anyone lending money (like home sellers, credit unions, mortgage lenders and banks, for instance) can issue a promissory note. But specific to real estate and the mortgage process, promissory notes serve as an agreement that the borrower will repay their mortgage loan by the maturity date.
A valid promissory note only needs the signatures of the participating parties involved in the agreement, not necessitating acknowledgment or being witnessed by a notary public to be legitimate.