A Promissory Note records all the terms and conditions of a loan transaction between a borrower and a lender before any money changes hands.
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What Is a Promissory Note?
A promissory note is a written promise by a borrower to repay a loan to a lender according to predetermined terms and conditions.
Before the requested fund is provided, the lender and the borrower document terms that have been mutually agreed upon on a promissory note, such as the repayment schedule, interest rates, and collaterals.
After the note is signed, the borrower receives the amount promised by the lender and pays back the loan according to the terms. Eventually, the lender will release the borrower from the promissory note once the loan is completely paid off.
When Should I Use a Promissory Note?
Common scenarios in which you may use a promissory note can include:
- Informal loans: lending money to friends or family members;
- Real estate loans: providing private mortgage to a home buyer;
- Business loans: financing a business for start-up or expansion;
- Vehicle loans: funding for the purchase of a car, boat, or other motor vehicle
Promissory notes are typically used for less complex loans or when there is a prior acquaintance between the lender and the borrower. By using promissory notes, lenders ensure legal protection for themselves in the event of a borrower’s failure to return the borrowed money.
How to Write a Promissory Note
Step 1: State the parties
Start by identifying both the borrower (the party receiving the loan) and the lender (the party who will be paid back).
The parties can be an individual or a business entity, such as a corporation or LLC. If either party to the promissory note is a business entity, a representative must sign on the entity’s behalf.
All lenders or borrowers should include their names on the note if there is more than one lender or borrower.
If the borrower’s financial stability is questionable, the lender may demand a cosigner with good credit as a safety net for the promissory note. By jointly signing the note, the cosigner undertakes to settle the loan if the borrower does not pay it back.
Step 2: Outline repayment terms
Next, you should clearly outline the following details about the loan and how it will be paid back:
- Principal amount: The total amount of money borrowed;
- Payment schedule: If the borrower plans to pay in installments, in a lump sum, or on demand;
- Collateral: If the borrower needs to guarantee the loan with their asset(s) and secure the note;
- Late fee: Whether there will be an additional fee if the payment is not made on time;
- Interest: If there will be any interest added to the loan and at what rate;
- Acceleration: If the lender can ask for the whole loan to be paid back at once, regardless of the original payment plan;
- Prepayment: If the borrower can pay back the loan early without any extra charges;
- Consequence: What happens if the borrower cannot repay the loan.
When determining repayment terms, the lender should consider carefully the borrower’s financial condition and the risks associated with the loan.
For example, if your borrower has low credit, you may opt for a secured promissory note in case the borrower defaults. If your borrower expects a large sum of money in the future, one lump sum payment may be more appropriate than installment payments.
Determining the Payment Schedule
To help you make an informed decision, below is a glance at the pros and cons of the three typical payment schedules for promissory notes:
Lump Sum
- What it is: A one-time payment where the borrower pays the total amount at the end of the loan term.
- Suitable for: Individuals who anticipate having the total amount of the loan available by a specific date (i.e., from a tax refund, an inheritance, a bonus at work)
Due on Demand
- What it is: The lender can demand immediate payment at any time.
- Suitable for: Individuals or businesses lending to someone they trust deeply, like a close friend or family member, or in cases where the lender wants flexibility in requiring repayment.
Installments
- What it is: The loan is repaid in regular, set amounts over time.
- Suitable for: Most traditional loan scenarios, such as personal loans, auto loans, and home mortgages, where the borrower pays the loan over time in regular amounts.
Step 3: Consider additional terms
Before you complete the promissory note, consider including additional provisions to make your note more comprehensive, such as:
- Amendment: How the note could be altered;
- Governing law: Which state laws that will be applied for the note;
- Joint and several liability: How all co-borrowers share responsibility for the repayment of the note, collectively and individually;
- Right to transfer: If the lender has the right to transfer the promissory note to a different party and have them collect payment instead.
Step 4: Sign the note
Once the principal terms of the note are agreed upon, the borrower should sign the note. While it is optional, including the lender’s signature is also good practice.
Although not legally required, it is recommended to notarize the promissory note if the loan involves a significant amount of money or when the terms are complex or could potentially be disputed.
Only after the note is signed should money be exchanged. In addition, every party to the note should get a copy, and the lender should store the original securely.
Step 5: Enforce the note
Generally speaking, there are three potential outcomes once a promissory note is in effect:
- Timely repayment
If the borrower repays the total amount per the note’s conditions, the lender should provide a loan release form to relieve the borrower of any further obligations related to the note.
- Delayed repayment
In case of late payment, the lender is required to issue a demand letter requesting the payment and any applicable late fees. If the borrower still fails to make up for the payment, the lender must evaluate the financial viability of initiating legal action.
- Non-repayment
If the borrower defaults on payment completely, the lender can pursue repayment (and collateral repossession, if applicable) via small claims court (a less expensive venue that doesn’t permit attorney representation, thereby eliminating attorney’s fees) for loans under the state limit. Litigation may be necessary if the loan amount exceeds the lender’s state limit.
Taking Legal Action
A comprehensive list of documents required when pursuing legal action for non-payment of a promissory note may include:
- The note itself. The original agreement that indicates the borrower’s promise to pay and contains your signatures. A copy will suffice if the original is lost.
- The demand letter. This serves as proof that you have formally demanded repayment.
- Correspondence. Any emails, letters, or other communications with the borrower regarding the loan and repayment.
- Other supporting documentation. This might include collateral agreements, personal guarantees, or other relevant contracts.
- Specific small claims court forms (if applicable). Depending on your location and the claim amount, you may need to fill out specific forms for small claims court.
It’s important to consider that litigation costs may exceed the recoverable amount. Furthermore, even if a judgment is in favor of the lender, recouping the funds can be challenging if the borrower lacks the financial means to settle the debt.
Why Use a Promissory Note?
- Legal recourse: It provides a lender with legal recourse if a borrower fails to repay the loan;
- Evidence of debt: It acts as a record of the transaction that can be used for accounting and tax purposes;
- Additional flexibility: Its transferability offers lenders an effective way to manage risk.
Usury Limits by State
Usury is the illegal practice of setting the interest rate on debt (including all extra charges like fees and discount points) higher than the maximum limit set by the relevant law or beyond what’s allowed in an exception to the law. Usury rates, consequently, refer to illegally high-interest rates that exceed that maximum limit.
Each state has different legislation on usury. Find the maximum interest rate you can charge legally in your state in the Usury Limits table below.
| State | Maximum Annual Rate | Additional Notes | Law |
|---|---|---|---|
| Alabama | 6%; 8% if agreed upon in writing | Excluding loans over $2,000 | Ala. Code § 8-8-1 |
| Alaska | Federal funds rate + 5%; 10.5% if no contract | Excluding loans over $25,000 | Alaska Stat. § 45.45.010 |
| Arizona | 10%; no limit if agreed and contracted upon | Ariz. Rev. Stat. Ann. § 44-1201 | |
| Arkansas | Federal discount rate + 5% (capped at 17%) | Capped at 17% | Ark. Const. Art. XIX §13 |
| California | 7%; 12% if agreed upon | Cal. Const. Article XV, § 1 | |
Promissory Note Sample
Refer to the free sample or download a customizable promissory note template below.
PROMISSORY NOTE
State of ___________
Amount: $________ [Principal amount]
Dated: ___________, 20___
FOR VALUE RECEIVED, the undersigned _____________________________ [Name of borrower(s)], (collectively “Borrower”), hereby promises to pay to the order of _____________________________ [Name of lender(s)], (collectively “Lender”), the principal sum of $________ (the “Principal Amount”) including interest in accordance with the terms set forth below.
1. Payment. The Principal Amount together with any accrued and unpaid interest and all other charges, costs and expenses, is due and payable on: (Check one)
☐ ___________, 20___.
☐ demand of the Lender.
All payments under this Note are applied first to any accrued interest and then to the Principal Amount.
2. Payment Schedule. (Check one)
☐ This Note shall be payable in installments equal to $________. The first payment is due on ___________, 20___ and due thereafter in equal consecutive installments every: (Check one)
☐ Month
☐ Quarter
☐ Year
☐ Other: ______________
☐ This Note shall NOT be payable in installments.
3. Security. (Check one)
☐ This is a secured note. Borrower agrees that until the Principal Amount of this Note together with any interest is paid in full, this Note will be secured by _________________________________ [Collateral], and Borrower hereby grants to Lender a security interest in and to such property.
☐ This is an unsecured note.
4. Interest. (Check one)
☐ The Principal Amount shall bear interest at the rate of $________ per annum, accruing daily. Notwithstanding, the total interest charged on the Principal Amount shall not exceed the maximum amount allowed by law and Borrower shall not be obligated to pay any interest in excess of such amount.
☐ The Principal Amount shall NOT bear interest.
5. Late Fee. (Check one)
☐ If Borrower fails to make a payment due under this Note within _____ days after the due date, Borrower agrees to pay to Lender a late payment fee of: (Check one)
☐ $________.
☐ ________% of the amount then due.
☐ A late payment fee will NOT be charged.
6. Acceleration. (Check one)
☐ In the event Borrower is more than _____ days late with a payment, Lender in its sole discretion may demand that the entire balance of the unpaid principal amount of this Note and any accrued and unpaid interest be immediately due and payable in full.
☐ This note will NOT be accelerated if a payment is late.
7. Prepayment. (Check one)
☐ Borrower has the right to prepay all or any part of the Principal Amount of this Note at any time without prepayment penalty or premium of any kind. Borrower must provide _____ days prior written notice to Lender of the prepayment and the amount of the prepayment. ( ☐ If Borrower pays all of the Principal Amount, together with any accrued interest, on or before ___________, 20___, Lender will give a discount of $________ of the outstanding Principal Amount due.)
☐ Borrower may NOT prepay the note.
8. Costs and Fees. Upon the occurrence of a default by Borrower, Borrower shall pay to Lender all costs of collection, including reasonable attorney’s fees.
9. Waiver. Borrower and all sureties, guarantors and endorsers hereof, waive presentment, protest and demand, notice of protest, demand and dishonor and nonpayment of this Note.
10. Guaranty. ______________ located at __________, __________, __________ __________ (“Guarantor”) promises to unconditionally guarantee to Lender, the full payment and performance by Borrower of all duties and obligations arising under this Note. Guarantor agrees that this guaranty shall remain in full force and effect and be binding on Guarantor until this Note is satisfied.
11. Assignment. Borrower may not assign its rights or delegate its duties under this Note without Lender’s prior written consent.
12. Joint and Several Liability. The obligation of each Borrower under this Note shall be joint and several.
13. Amendment. This Note may be amended or modified only by a written agreement signed by Borrower and Lender.
14. Notifications. Any notice or communication under this Note must be in writing and either personally delivered, sent by overnight courier service, certified or registered mail, postage prepaid, return receipt requested or by facsimile or electronic email transmission.
15. Governing Law. This Note shall be governed by and construed in accordance with the laws of the State of ____________.
16. Miscellaneous. This Note will inure to the benefit of and be binding on the respective successors and permitted assigns of Lender and Borrower. Lender shall not be deemed to have waived any provision of this Note or the exercise of any rights held under this Note unless such waiver is made expressly and in writing. Waiver by Lender of a breach or violation of any provision of this Note shall not constitute a waiver of any other subsequent breach or violation. In the event that any of the provisions of this Note are held to be invalid or unenforceable in whole or in part, the remaining provisions shall not be affected and shall continue to be valid and enforceable as though the invalid or unenforceable parts had not been included in this Note.
IN WITNESS WHEREOF, the undersigned has executed this Note as of the date first stated above.
SIGNATURES
Borrower Signature: ________________________
Borrower Full Name: ________________________
Guarantor Signature: ________________________
Guarantor Full Name: ________________________
Lender Signature: ________________________
Lender Full Name: ________________________
Frequently Asked Questions
What makes a promissory note invalid?
A promissory note may be invalid if:
- It lacks essential elements like the amount owed, the interest rate, and the repayment terms;
- It was signed under duress (i.e., someone was threatened or forced to sign it);
- It involves illegal activity (i.e., loan sharking or money laundering);
- It’s forged or fraudulently altered.
Does a promissory note need to be recorded?
Typically, promissory notes are not recorded with the county and are retained by the lender. Only those notes involving real estate are typically recorded.
Can a promissory note be signed electronically?
Yes, a promissory note can be signed electronically. The validity of electronic signatures is recognized under the E-Sign Act.
However, it’s important to ensure that the process follows all relevant laws and standards in your jurisdiction.
How long is a promissory note valid?
A promissory note can last 3-15 years, depending on the jurisdiction. As it is essentially a legally binding contract, its statute of limitation is generally the same as that of other written contracts.
However, this period extends to 15-30 years for real estate-related notes.