A promissory note is a legal and debt instrument that acts as a written promise where one party promises to pay another when money is given as a loan. It must be signed by both parties and it details how and when the originally loaned money should be returned to the lender.
Promissory notes function in quite similar ways to loan contracts and loan agreements and can be highly useful for lenders and borrowers looking for security and stability when money is loaned. They are not quite as flexible as IOUs but don’t have the same legal clout as formal contracts. They instead occupy a happy medium between the two.
To help yo understand these financial instruments better, this article looks in more depth at promissory notes. It explains more about what kind of details these important notes document and the different types that you might encounter in practice.
What Information Does a Promissory Note Contain?
Promissory notes must be properly written to be properly effective. To ensure that payment terms are clear and that both parties can easily understand their obligations, promissory notes usually contain details on the following:
- The names of the lenders and the borrowers.
- How much money is being loaned (this is known as the principal sum).
- When the money should be repaid.
- How the money should be repaid (i.e. in installments, a lump sum, etc).
- If the money that was loaned is subject to any interest rates (these must adhere to state usury laws in order for the agreement to be valid).
- What shall be done in the case of a default of the money?
- Details on any collateral that will be used to secure the loan.
Types of Promissory Notes
Promissory notes can be used for many different purposes. They are most often used for quick and short term financing or with a borrower who can manage the level of risk.
Two common types of promissory notes include:
- Corporate credit promissory notes: These offer a line of short term credit to companies if they are suffering from cash flow issues or need a quick injection of capital that can be repaid quickly in the near future.
- Investment promissory notes: This is a note that can only be used by corporations or high-level investors that have the capacity to take on a high level of risk in the same way a bank would. These documents normally need to be notarized on signing.
Promissory notes aren’t only limited to these uses. They may also be used to secure family loans, purchasing a vehicle, and to finance real estate purchases when necessary.
However you use a promissory note, it offers an assurance that a lender or borrower is serious in honoring their agreement without creating anything as formal or severe as a loan agreement. This makes it ideal for people looking for an informal yet safe way of lending money or for those who have exhausted other financing options.