An IOU is an informal note that promises to pay a debt. It is so-called as it is a phonetic match for “I Owe You” and it also abbreviates the first letters of each word.

IOUs can be used for many purposes although they are not usually used by banks or issuing large amounts of formal debt. Most commonly they are used to acknowledge a small monetary debt between two trusting parties. Read on to learn how IOUs work in practice and some of the legal contract alternatives to it as a note payable form.

How Do IOUs Work?

IOUs are the most basic of notes payable but in order to have any validity, they must contain a number of important details. This includes the following information about a debt:

  • The names of the debtor and the lender
  • The amount of money that has been loaned
  • Interest that will be paid (optional)
  • When the money must be repaid
  • The signature of the debtor

It must be remembered that an IOU is not a legal agreement and it relies entirely on the trust of the lender that the borrower will comply as stated. There is more difficulty in legally enforcing an IOU compared to other options such as a promissory note or a loan contract.

An IOU is also not a negotiable instrument as it lacks the same level of detail on the repayment of the principal sum that can be found within other documents. This means that the debt that it details cannot be sold to another party.

Other Uses of the Term IOU

The term IOU isn’t only used to record informal debts between friends and family. It is sometimes used by financial institutions in certain situations.

One example is in the bond market. Bonds are technically a form of IOU, whereby an individual loans an amount of money to a company or government and is given a contract promising to repay the money with interest by a certain date. Whilst this agreement is sometimes referred to as an “IOU”, it is in fact legally binding.

California Registered Warrants are also sometimes called “IOUs”. These note payable documents are a promise of payment on a future date from the State of California itself and are issued when the treasury cannot pay a cost immediately. They are also not negotiable instruments like regular IOUs.

The term IOU is also sometimes used in the world of Bookkeeping. In this case, it refers to a debt that is yet to be paid to the company or organization in question and that can be counted as a net asset on its balance sheet.

Alternatives to IOUs

IOUs are considered the most flexible and informal examples of debt notices. They do not have the same legal enforceability as other types of note payable forms. If you wish to issue a debt whilst ensuring the best chance of being able to collect the money owed if a default occurs, lenders can use the following:

  • Promissory Notes: A promissory note is a negotiable instrument that summarizes the promise to pay a debt. The money owed must be paid at a certain time in the future or can be requested on-demand depending on how the note is written. Promissory notes are most often used to securely issue credit from smaller lenders.
  • Loan Agreements: Loan agreements are formal financial contracts that outline the obligations of creditors and debtors when repaying a debt. They are used by most banks and financial institutions to issue loans to individuals and businesses.