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A promissory note is essentially a promise to pay. It is a contract between two parties, in which one party promises to pay the other party a certain amount of money at some future date.

The document also specifies the principal amount owed and interest rate or other charges that may accrue on the loan.

You can use a promissory note can be used in any situation where one person borrows money from another person or business, for expenses such as home mortgages and student loans.

A promissory note also includes details about how much you're borrowing, and how long it takes before you must start paying back your debt (the maturity date) when payments will be made.

The document will also typically specify whether there are penalties if you fail to make payment on time. Promissory notes are used in different kinds of transactions, including as security for loans. They can also be used to document a gift or donation.

While they are all generally the same idea, there are different types of promissory notes.

In this article, we’ll go over how promissory notes work, as well as the different types you can use and which may be best for you.

How Does a Promissory Note Work?

A promissory note is a written document signed by the maker of the note and promises to pay the payee a certain amount of money.

They work similarly to an IOU, however, they are much more legally enforceable.

The main purpose of a promissory note is to borrow money. Typically, promissory notes are used when someone wants to borrow money from another person or company (the lender).

For a promissory note to be considered valid, the following should be included in the legal document:

  • Names of the lender and borrower
  • Amount of the loan
  • How the loan will be repaid
  • Any interest that must be paid
  • Any collateral will be part of the loan
  • Consequences for the borrower if they fail to pay

LawDistrict offers a Promissory Note template to help you create your document easily without having to pay a lawyer.

Types of Promissory Note Payments

If you are lending money or receiving money, you can choose a repayment plan that works best for you and the other party.

Payments can be made in one of two ways:

  • Lump sum
  • Installments

Typically, if you opt for an installment plan, the payments will be made monthly. However, you can also decide on a different period.

The borrower must make payments on the due date, complying with the terms of the promissory note.

If you are a borrower and fail to make timely payments, it could result in penalties from late fees to collection costs and even damage your credit score.

As a lender, you can use a bill of exchange if the borrower has not made a payment.

Promissory Notes vs. Loan Agreements

Promissory notes are often compared with loan agreements, however, they have some key differences.

In certain situations, you may benefit more from using a promissory note and in other circumstances, a loan agreement may be better.

Review the key differences between promissory notes and loan agreements in the table below.

Promissory Note Loan Agreement
Better for smaller amounts and short-term loans. There are more severe consequences if the terms and conditions are violated.
More informal loan. More formal and complex.

Different Types of Promissory Notes

Promissory notes are classified according to the use of collateral. There are two main types:

  • Secured: Secured promissory notes are backed by collateral, such as a house or car.
  • Unsecured: Unsecured promissory notes have no security attached to them at all, other than the word of the borrower (or co-borrower).

You can create an unsecured promissory note if you trust the borrower and their ability to repay you.

There are specific promissory notes used for various purposes, such as:

  • Simple promissory note: This type of agreement can be used for any purpose.
  • Student loan promissory note: These are generally made between students and the government, but can also be made with parents. The purpose is to pay for the student’s expenses, which must be paid back after the student graduates.
  • Personal loan promissory note: This promissory note is used when a loan is made with a friend or family member.
  • Car promissory note: If money is loaned for a borrower to purchase a car, this should be used. It should include the car’s make and model.
  • Commercial promissory note: This promissory note is best when a bank or agency loans money to a borrower.
  • Investment promissory note: If a business needs an influx of money, this type of note can be used and the loan is usually expected to be repaid quickly.
  • Real estate promissory note: This is used specifically for the purchase of a property. The property can be used as collateral.

What Makes a Promissory Note Invalid?

While a promissory note is an essential financial tool, it can also be considered invalid if created or finalized incorrectly. Here are some examples of what makes a promissory note invalid:

  • Failure to sign: If the party does not sign the document.
  • Unclear clauses: If there are terms in it that make it difficult for someone to understand what they're signing up for.
  • Unfair conditions: Terms and conditions that are deemed unfair towards one party could invalidate the document.
  • A witness isn't involved: Even though this isn't always required by law; however, having one may help strengthen your case if any disputes arise.

Promissory notes are a powerful tool for business owners to use when financing their company.

Depending on the exact circumstances regarding your loan, it will be critical to decide on the right type of promissory note.

By studying the previous information, you will be able to make the decision that is best for both you and the other party involved.

Helpful Resources:

What makes a promissory Note | LawDistrict

Promissory Note: Promises and Problems | SEC.Gov

A promissory note is essentially a promise to pay. It is a contract between two parties, in which one party promises to pay the other party a certain amount of money at some future date.

The document also specifies the principal amount owed and interest rate or other charges that may accrue on the loan.

You can use a promissory note can be used in any situation where one person borrows money from another person or business, for expenses such as home mortgages and student loans.

A promissory note also includes details about how much you're borrowing, and how long it takes before you must start paying back your debt (the maturity date) when payments will be made.

The document will also typically specify whether there are penalties if you fail to make payment on time. Promissory notes are used in different kinds of transactions, including as security for loans. They can also be used to document a gift or donation.

While they are all generally the same idea, there are different types of promissory notes.

In this article, we’ll go over how promissory notes work, as well as the different types you can use and which may be best for you.

How Does a Promissory Note Work?

A promissory note is a written document signed by the maker of the note and promises to pay the payee a certain amount of money.

They work similarly to an IOU, however, they are much more legally enforceable.

The main purpose of a promissory note is to borrow money. Typically, promissory notes are used when someone wants to borrow money from another person or company (the lender).

For a promissory note to be considered valid, the following should be included in the legal document:

  • Names of the lender and borrower
  • Amount of the loan
  • How the loan will be repaid
  • Any interest that must be paid
  • Any collateral will be part of the loan
  • Consequences for the borrower if they fail to pay

LawDistrict offers a Promissory Note template to help you create your document easily without having to pay a lawyer.

Types of Promissory Note Payments

If you are lending money or receiving money, you can choose a repayment plan that works best for you and the other party.

Payments can be made in one of two ways:

  • Lump sum
  • Installments

Typically, if you opt for an installment plan, the payments will be made monthly. However, you can also decide on a different period.

The borrower must make payments on the due date, complying with the terms of the promissory note.

If you are a borrower and fail to make timely payments, it could result in penalties from late fees to collection costs and even damage your credit score.

As a lender, you can use a bill of exchange if the borrower has not made a payment.

Promissory Notes vs. Loan Agreements

Promissory notes are often compared with loan agreements, however, they have some key differences.

In certain situations, you may benefit more from using a promissory note and in other circumstances, a loan agreement may be better.

Review the key differences between promissory notes and loan agreements in the table below.

Promissory Note Loan Agreement
Better for smaller amounts and short-term loans. There are more severe consequences if the terms and conditions are violated.
More informal loan. More formal and complex.

Different Types of Promissory Notes

Promissory notes are classified according to the use of collateral. There are two main types:

  • Secured: Secured promissory notes are backed by collateral, such as a house or car.
  • Unsecured: Unsecured promissory notes have no security attached to them at all, other than the word of the borrower (or co-borrower).

You can create an unsecured promissory note if you trust the borrower and their ability to repay you.

There are specific promissory notes used for various purposes, such as:

  • Simple promissory note: This type of agreement can be used for any purpose.
  • Student loan promissory note: These are generally made between students and the government, but can also be made with parents. The purpose is to pay for the student’s expenses, which must be paid back after the student graduates.
  • Personal loan promissory note: This promissory note is used when a loan is made with a friend or family member.
  • Car promissory note: If money is loaned for a borrower to purchase a car, this should be used. It should include the car’s make and model.
  • Commercial promissory note: This promissory note is best when a bank or agency loans money to a borrower.
  • Investment promissory note: If a business needs an influx of money, this type of note can be used and the loan is usually expected to be repaid quickly.
  • Real estate promissory note: This is used specifically for the purchase of a property. The property can be used as collateral.

What Makes a Promissory Note Invalid?

While a promissory note is an essential financial tool, it can also be considered invalid if created or finalized incorrectly. Here are some examples of what makes a promissory note invalid:

  • Failure to sign: If the party does not sign the document.
  • Unclear clauses: If there are terms in it that make it difficult for someone to understand what they're signing up for.
  • Unfair conditions: Terms and conditions that are deemed unfair towards one party could invalidate the document.
  • A witness isn't involved: Even though this isn't always required by law; however, having one may help strengthen your case if any disputes arise.

Promissory notes are a powerful tool for business owners to use when financing their company.

Depending on the exact circumstances regarding your loan, it will be critical to decide on the right type of promissory note.

By studying the previous information, you will be able to make the decision that is best for both you and the other party involved.

Helpful Resources:

What makes a promissory Note | LawDistrict

Promissory Note: Promises and Problems | SEC.Gov