What is a Promissory Note?

What is a Promissory Note?

by Brette Sember, Esq., June 2016

A promissory note is essentially a written promise to pay someone. This type of document is common in financial services and is something you've likely signed in the past if you've taken out any kind of loan. If you decide to lend money to someone, you may want to create a promissory note to formalize the loan.

What Is a Promissory Note?

Promissory notes may also be referred to as an IOU, a loan agreement, or just a note. It's a legal lending document that says the borrower promises to repay to the lender a certain amount of money in a certain time frame. This kind of document is legally enforceable and creates a legal obligation to repay the loan.

When Is It Used?

A promissory note is used for mortgages, student loans, car loans, business loans, and personal loans between family and friends. If you are lending a large amount of money to someone (or to a business), then you may want to create a promissory note from a promissory note template. This note will be a legal record of the loan and will protect you and help make sure you are repaid.

What Should Be Included?

A loan promissory note sets out all the terms and details of the loan.

The promissory note form should include:

  • The names and addresses of the lender and borrower
  • The amount of money being borrowed and what, if any, collateral is being used
  • How often payments will be made in and in what amount
  • Signatures of both parties, in order for the note to be enforceable

The collateral referenced above is property that the lender can seize if the note is not repaid; for example, when you buy a home, the house is the collateral on the mortgage.

Customizing a Promissory Note

Promissory notes should be created to fit the transaction that you are involved in. It's always good to refer to a sample promissory note when you are writing one, so that you can be sure to include the right language. There also are different types of promissory notes.

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. There may or may not be interest charged on the loan amount, depending on what you've agreed.

A demand promissory note is one in which payment is due when the lender asks for the money back. Usually a reasonable amount of notice is required.

More complicated promissory notes for transactions like mortgages and car loans will also include interest rates, amortization schedules, and other details.

How to Collect on a Promissory Note

If you've lent money to someone using a promissory note, the plan is for them to repay you according to the terms of the note, which in most cases is what happens. But what if they don't meet the terms of the note?

The first thing to do is actually to ask for the repayment in writing. A written reminder or request is often all that is needed. You could send past due notices at 30, 60, and 90 days after the due date.

Be sure to talk to your borrower. Can they make a partial payment? Would an extended payment plan allow them to pay up? If you decide to accept a partial repayment of the debt, then you can create a debt settlement agreement with your borrower.

Another option is to use a debt collector. This business will work to collect your note and will usually take a percentage of the debt. You also can sell the note to a debt collector, meaning they own the loan and collect the full amount (this is similar to what happens when banks sell loans to each other). If all else fails, you can sue the borrower for the full amount of the debt.

Promissory notes are a useful way to establish a clear record of a loan—whether between entities or individuals—and to put all the relevant terms in writing, so that there can be no question about the amount of money lent and when payments are due. 

Creating a promissory note online is fast and easy through LegalZoom. Customize and download a secure or unsecured promissory note to minimize confusion and misunderstanding when loaning or borrowing money.