- What Is a Promissory Note?
- State-Specific Promissory Notes
- Secured and Unsecured Promissory Notes
- What Promissory Notes Are Not
- When Should I Use a Promissory Note?
- How to Write a Promissory Note
- Enforcement of a Promissory Note
- Usury Limits by State
- Promissory Note Sample
- How Legal Templates Helps with Promissory Notes
- Frequently Asked Questions
What Is a Promissory Note?
A promissory note is a written agreement where one party promises to repay a specific loan amount to another under agreed-upon terms. It clearly outlines repayment schedules, interest rates, and any applicable penalties, ensuring both parties understand their obligations.
This document provides a clear framework for trust, clarity, and accountability in personal loans, business funding, or real estate transactions.
When Should You Use a Promissory Note?
If you’re lending money to a friend or family member or helping finance a personal project, a promissory note can provide clarity and protection for everyone involved. By putting the loan terms in writing, both parties understand the expectations, reducing the risk of misunderstandings or disputes down the line.
Here are a few situations where a promissory note can be especially helpful:
- Personal Loans: When you’re lending money to someone you trust, setting clear terms can ensure both sides are on the same page.
- Real Estate: If you’re helping someone finance a property purchase or lending money for home repairs, a promissory note makes the agreement official.
- Business Loans: Whether you’re funding a new business or helping with expansion, a promissory note ensures the loan is documented and enforceable.
State-Specific Promissory Notes
Promissory notes must meet specific legal requirements depending on the state. Our state-specific guides provide tailored information on local laws, interest rate limits, and statutes of limitations. Confidently complete your state-compliant promissory note using our editor.
- Alabama
- Alaska
- Arizona
- Arkansas
- California
- Colorado
- Connecticut
- Delaware
- District of Columbia
- Florida
- Georgia
- Hawaii
- Idaho
- Illinois
- Indiana
- Iowa
- Kansas
- Kentucky
- Louisiana
- Maine
- Maryland
- Massachusetts
- Michigan
- Minnesota
- Mississippi
- Missouri
- Montana
- Nebraska
- Nevada
- New Hampshire
- New Jersey
- New Mexico
- New York
- North Carolina
- North Dakota
- Ohio
- Oklahoma
- Oregon
- Pennsylvania
- Rhode Island
- South Carolina
- South Dakota
- Tennessee
- Texas
- Utah
- Vermont
- Virginia
- Washington
- West Virginia
- Wisconsin
- Wyoming
Secured and Unsecured Promissory Notes
Different loans require different approaches. A secured promissory note uses collateral to reduce risk, while an unsecured note relies solely on the borrower’s promise to repay. Use the table below to quickly compare these options and choose the best fit for your needs.
| Feature | Secured Note | Unsecured Note |
|---|---|---|
| Collateral | Backed by an asset. | No collateral required. |
| Risk for lender | Lower due to collateral. | Higher without collateral. |
| Interest rates | Lower, less lender risk. | Higher, more lender risk. |
| Common uses | Real estate, business. | Personal, small loans. |
Secured
A document used to include collateral in a high-stakes loan.
Unsecured
A document used for quick loans with trustworthy borrowers.
Can the Loan Be Sold or Transferred?
Not all promissory notes are created equal—some are negotiable, and others are not. In a negotiable promissory note, the lender can sell the loan to a third party, transferring the right to collect the loan to someone else.
On the other hand, non-negotiable promissory notes mean only the original lender can collect the debt, so there’s no risk of the borrower suddenly dealing with a different party.
If you are creating a promissory note, it’s important to decide whether or not you want the note to be negotiable. If so, the terms should reflect that flexibility, providing an easy way for the lender to transfer the note if necessary.
What Promissory Notes Are Not
While promissory notes are valuable tools for documenting loan agreements, it’s important to understand their limitations. Here’s what they don’t do:
- They aren’t a full loan agreement: Promissory notes focus solely on repayment terms, while loan agreements cover broader details like loan purpose and additional conditions.
- They don’t guarantee repayment: A promissory note creates a legal obligation, but repayment still depends on the borrower’s ability and willingness to pay.
- They aren’t informal IOUs: Unlike IOUs, promissory notes are formal, legally binding documents with specific terms.
- They aren’t for services or goods: Promissory notes are designed exclusively for monetary loans, not for bartering or service agreements.
When Should I Use a Promissory Note?
Promissory notes are ideal for documenting loans in various situations. They provide clear terms, legal protection, and peace of mind for both lenders and borrowers. There are different types of promissory notes; common uses include:
- Formalizing personal loans: Create clear repayment terms when lending money to friends or family for emergencies or significant purchases.
- Securing real estate financing: Document private mortgages or property purchase contributions with agreed-upon terms.
- Funding business growth: Establish repayment plans for startups, expansions, or equipment purchases.
- Purchasing vehicles or equipment: Ensure repayment expectations are clear when financing cars, boats, or machinery.
- Covering educational expenses: Set repayment terms for tuition, training, or other education-related costs.
- Managing medical expenses: Provide financial support for treatments or procedures with a structured agreement.
Promissory notes are particularly useful when trust exists between the lender and borrower, but formal documentation is needed to protect both parties.
How to Write a Promissory Note
Creating a promissory note is straightforward when you know the key elements to include. Follow these steps to ensure your document is clear, legally enforceable, and tailored to your needs:
1. Identify the Parties
Start by listing the borrower (the person or entity receiving the loan) and the lender (the person or entity providing the loan). If either party is a business, include the business name and ensure an authorized representative signs the note.
If the lender is concerned about the borrower’s financial stability, they can request a cosigner. The cosigner agrees to take responsibility for the loan if the borrower defaults.
How to Verify Financial Status
To assess the borrower’s financial reliability, you can request their credit report. Borrowers can access free annual credit reports through websites like AnnualCreditReport.com or as part of certain credit card services. Paid financial status checks from online agencies are also an option for additional assurance.
2. Define the Loan Terms
Clearly outline the loan’s details to ensure everyone understands the agreement. Include the following:
- Loan amount: Specify the exact amount the borrower will receive.
- Repayment schedule: Define how and when payments will be made—installments, lump sum, or on demand.
- Interest rate: State the percentage rate and confirm it complies with state usury laws.
- Collateral: List any assets being used to secure the loan, such as property or a vehicle.
- Due date: Include the final date by which the loan must be fully repaid.
- Late payment penalties: Explain the fees or consequences for missed or delayed payments.
- Default terms: Detail the lender’s rights if the borrower cannot fulfill their obligations, such as requiring immediate repayment.
- Prepayment terms: Indicate whether the borrower can repay the loan early and if there are any conditions or penalties for doing so.
Use simple, specific language to avoid misunderstandings and ensure the terms are enforceable.
3. Include Additional Terms
These optional clauses can make your promissory note more comprehensive:
- Amendments: Define how changes to the agreement can be made.
- Governing law: State which jurisdiction’s laws will apply to the agreement.
- Prepayment: Specify whether the borrower can repay the loan early without penalties.
- Joint and several liability: If there are multiple borrowers, state that they share equal responsibility for repayment.
- Right to transfer: Indicate whether the lender can transfer the note to another party.
Adding these provisions upfront can prevent disputes later.
4. Sign and Distribute the Note
All parties, including any cosigners, should sign the promissory note to indicate their agreement to its terms. While notarization isn’t required for most promissory notes, it’s a good idea for larger or more complex loans.
Tips for Signing
- Sign the note: Both parties, including any cosigners, should sign the note to make it legally binding.
- Store it securely: Keep the original note in a safe place, such as a lockbox or a fireproof safe.
- Make copies: Ensure both parties have copies of the signed note for their records.
- Backup digitally: Store a digital copy in a secure location, such as Legal Templates’ document editor, for easy access.
5. Enforce the Agreement (If Necessary)
If the borrower fails to meet their repayment obligations, you can take these steps to enforce the promissory note:
- Issue a demand letter: Send a formal demand for payment letter reminding the borrower of the loan terms and requesting payment by a specific date.
- File in small claims court: Pursue repayment through small claims court for loans under the state limit. This process is cost-effective and typically doesn’t require legal representation.
- Recover collateral: For secured promissory notes, reclaim the pledged asset, such as property or a vehicle, according to the terms outlined in the note.
- Explore additional legal options: If the loan exceeds small claims limits or the borrower continues to default, you may need to file a lawsuit in a higher court.
If the borrower fulfills their obligations, the lender can issue a promissory note release to formally acknowledge that the loan terms have been satisfied. This document serves as proof that the debt has been repaid, providing clarity and closure for both parties.
Enforcement of a Promissory Note
When a borrower defaults on a promissory note, the lender has options to protect their financial interests. Here’s what you need to know about enforcement, legal recourse, and state-specific considerations.
What Happens When a Borrower Defaults?
Default occurs when the borrower doesn’t fulfill their obligations under the promissory note, such as missing a payment or failing to repay by the due date. If this happens, the lender can:
- Send a demand letter: Request repayment in writing, specifying the outstanding amount, any late fees, and a payment deadline.
- Take legal action: Escalate the matter to court if the borrower doesn’t respond to the demand letter.
Legal Recourses for Lenders
If the borrower defaults on a promissory note, the lender has several legal options to recover the outstanding amount. The best course of action often depends on the loan amount, the terms of the note, and whether collateral is involved. Here are the primary legal avenues available:
Small Claims Court
- Handles smaller loan amounts (limits vary by state, typically $5,000–$10,000).
- Provides a streamlined process without the need for attorney representation.
- Outcomes can include repayment orders or authorization to repossess collateral.
Civil Court
- Required for loans that exceed small claims court limits.
- Allows lenders to seek judgments for wage garnishment, asset seizure, or liens.
- Typically involves higher legal fees and longer timelines.
Repossession or Foreclosure
- For secured promissory notes, the lender may claim the specified collateral, such as a car or property.
- This process is governed by state-specific rules for repossession or foreclosure.
Statutes of Limitations
Lenders have a limited time to enforce a promissory note, based on state-specific statutes of limitations. These timeframes vary depending on whether the note is secured or unsecured:
- Secured promissory notes: Often enforceable for 3 to 15 years, depending on the state.
- Unsecured promissory notes: Typically have shorter limits, ranging from 3 to 6 years.
Review your state’s statutes of limitations to ensure timely enforcement. Once the statute expires, the lender may lose legal options to recover the debt.
State-Specific Enforceability Laws
Enforceability of promissory notes depends on compliance with state laws, which may include:
- Usury limits: Interest rates must remain within the state’s legal maximum. Exceeding the cap may void the note.
- Notice requirements: Some states require lenders to notify borrowers in writing before pursuing legal action.
- Special exemptions: Loans above certain amounts or business loans may have unique rules or exceptions.
Key Terms to Strengthen Enforcement
A promissory note should include the following terms to ensure it’s enforceable in court:
- Default provisions: Clearly state what constitutes default and what actions the lender can take.
- Acceleration clause: Allow the lender to demand full repayment if the borrower defaults.
- Governing law clause: Specify which state’s laws will apply to the promissory note.
Usury Limits by State
Usury laws set the maximum interest rates lenders can charge on loans, protecting borrowers from excessively high rates. Each state has its own rules, and these limits often depend on the type of loan and its terms.
Key Points:
- Usury rates ensure fair lending practices by capping annual percentage rates (APRs).
- State-specific laws determine the maximum interest rates for personal loans, mortgages, and business financing.
- Exceeding these limits may result in penalties for the lender and render the loan unenforceable.
Here’s a summary of state usury limits:
| State | Maximum Annual Rate | Additional Notes |
|---|---|---|
| Alabama | 6%; 8% if agreed in writing | No limits on loans over $2,000 |
| Alaska | Federal funds rate + 5% | No limits on loans over $25,000 |
| Arizona | 10%; no limit if contracted | |
| Arkansas | Federal discount rate + 5% | Capped at 17% |
| California | 7%; 12% if agreed upon | |
Example
Alex, a small business owner, borrows $10,000 with a promissory note at a 25% interest rate. When Alex discovers that the state usury law caps interest at 15%, they renegotiate the terms to avoid legal issues.
Always check your state’s specific laws to ensure your loan complies with usury regulations. For detailed information, refer to the state-specific guides in the “By State” section above.
Promissory Note Sample
Below, you can see a sample promissory note. You can start creating yours today using our document editor.
How Legal Templates Helps with Promissory Notes
Legal Templates makes creating promissory notes quick and easy. Our attorney-designed tools ensure compliance with state laws, guiding you through every step to draft clear, enforceable agreements.
With our document editor, you can customize repayment terms, interest rates, and more in minutes. Save time, reduce errors, and gain peace of mind knowing your note is legally sound and tailored to your needs.
Frequently Asked Questions
What Makes a Promissory Note Invalid?
A promissory note may be invalid if:
- It doesn’t include essential details like the loan amount, repayment terms, or interest rate.
- One or both parties were forced or threatened into signing.
- It involves illegal activities such as loan sharking.
- The note has been forged or altered fraudulently.
How Can I Include Multiple Borrowers or Lenders in One Note?
To include multiple borrowers or lenders, you should:
- List each party by name and role (borrower, lender, or guarantor).
- Add a clause for “joint and several liability,” which holds all borrowers equally responsible for repayment.
- Ensure that all parties sign the document to confirm their agreement to the terms.
Can Promissory Notes Be Amended After Signing?
Yes, promissory notes can be amended, but only if all parties agree. To amend a note:
- Create a written document outlining the changes.
- Have all parties sign the amendment to confirm their agreement.
- Specify that the original terms remain in effect except for the amended sections.
What Happens If the Lender Wants to Sell the Note to Another Party?
The lender can sell a promissory note to another party through an assignment. To complete this process:
- Notify the borrower of the transfer.
- Ensure the new lender, called the “assignee,” assumes all rights to enforce the note.
- Maintain the original terms of the note unless all parties agree to changes.
How Should I Handle Interest-Free Loans Between Family Members?
For interest-free loans between family members, it’s essential to establish clear terms. Include:
- The loan amount and repayment schedule.
- A clause confirming that no interest will be charged.
- Penalties for late payments, even if interest is not applied.
This approach helps prevent misunderstandings and ensures accountability.
