Promissory Note

A promissory note establishes the core terms of a debt obligation, including the principal amount, interest rate, repayment schedule, and consequences of default.

A written promissory note can help prove that a debt exists and explain what the borrower promised to repay. If the borrower (payer) fails to pay, the lender (payee) may use the note as evidence when pursuing collection, subject to the note’s terms and applicable law. 

The document is similar to a loan contract, but it’s less formal and is commonly used when individuals lend money without the help of a bank.

How a promissory note works

The borrower usually signs the note before or when the lender provides the funds. The lender should keep the signed original or a reliable signed copy. When the debt is paid in full, the lender should provide written confirmation, release any collateral if applicable, and mark the note paid or satisfied.

A complete promissory note generally includes:

• Full names and addresses of both parties
• Principal loan amount
• Interest rate (if any) and how it is calculated
• Repayment schedule (installments, lump sum, or on demand)
• Maturity date
• Default provisions and lender remedies
• Whether the note is secured by collateral or unsecured
• Borrower’s signature

Key characteristics

A promissory note has specific legal features that affect its enforceability and whether it can move between parties. These characteristics define what makes a note valid and how it functions in practice.

• Unconditional promise. A promissory note must contain an unconditional commitment to pay. Conditions that must be met before repayment is required make it a conditional agreement, not a valid note.
• Transferability. Some promissory notes are negotiable instruments under the Uniform Commercial Code (UCC), meaning the lender can transfer or sell the note to a third party, who then becomes the new payee.
• Secured vs. unsecured. A secured note is backed by collateral that the lender can claim upon default. An unsecured note carries no collateral, making it riskier for the lender.
• Interest terms. A note may use a fixed rate, variable rate, or no interest. Interest terms must comply with applicable usury, lending, and tax rules. Below-market loans, including some family, employer-employee, and shareholder loans, may trigger IRS imputed-interest rules, so parties should review the applicable federal rate and get tax guidance when needed.

Common uses

People and businesses use promissory notes to document repayment terms in many lending situations.

• Business loans. A borrower and a private investor document repayment terms, the interest rate, and the schedule in a signed note.
• Real estate. Seller financing arrangements use a promissory note separate from the mortgage deed.
• Family loans. A written note prevents the IRS from treating the loan as a gift, which eliminates any deduction if the loan goes bad.
• Startup funding. A convertible promissory note allows early-stage debt to convert to equity at a future funding round.

Related terms

A promissory note intersects with several legal and business concepts that affect how it is enforced or transferred.

• Loan agreement: A loan agreement is a contract that sets the terms of a loan between a borrower and lender.
• Collateral: Collateral is property a borrower pledges to secure repayment of a debt.
• Secured debt: Secured debt is debt backed by collateral that the lender may be able to claim or sell after default.
• Default: Default occurs when a borrower fails to meet repayment or other obligations under a note or loan agreement.
• Demand note: A demand note is a promissory note that becomes payable when the lender demands payment.
• Convertible note: A convertible note is a debt instrument that may convert into equity under stated conditions.

FAQs about promissory note

What are the main types of promissory notes?

There are several different types of promissory notes. This includes the following:

• Secured promissory note. A secured promissory note means the loan is backed by collateral. This is typically physical property that the lender can use to settle your debt.
• Unsecured promissory note. An unsecured promissory note is one that’s not backed by collateral. Both are legally valid and legally binding.
• Demand promissory note. A demand promissory note gives the lender the right to demand full repayment at any time, even if the note specifies a repayment schedule. 
• Master promissory note. A master promissory note is a promise to repay student loans issued by the U.S. Department of Education.

What happens if a borrower defaults?

The lender can issue a demand letter, invoke an acceleration clause to make the full balance due immediately, and file a lawsuit to obtain a court judgment. If the note is secured, the lender may also have the right to seize or foreclose on the collateral.

What makes a promissory note legally invalid?

A note may be unenforceable if it lacks the borrower’s signature, contains ambiguous repayment terms, includes a conditional promise to pay, or sets an interest rate that violates applicable state usury laws.

Does a promissory note need to be drafted by an attorney?

Not always. A simple promissory note may be enforceable if it clearly identifies the parties, states the amount owed, explains repayment terms, and is signed by the borrower. Attorney review is helpful for larger loans, secured notes, real estate transactions, business financing, related-party loans, convertible notes, or loans involving multiple states.