A Secured Promissory Note details the borrower’s commitment to repay a loan while providing collateral as a security measure in case of loan default.
What Is a Secured Promissory Note?
In a secured promissory note, the borrower offers an asset as collateral to the lender. This creates a legal right known as a lien, which the lender holds over the borrower’s property until the debt is satisfied.
When to Use One
Secured promissory notes are commonly used when:
- The loan amount is significant. A survey conducted amongst our users in 2022 showed that only 24% chose to secure their promissory notes with collateral with principal amounts below $100,000. In contrast, over 40% of users with principal amounts exceeding $100,000 opted for a secured note, demonstrating the increased reliance on collateral to safeguard larger financial transactions.
- You can’t fully trust the borrower. If you are loaning to a buyer with less-than-ideal credit or little experience taking out loans, you may be concerned that they will not be able to repay the loan in full. A secured promissory note can give you more assurance.
- You give low-interest rates. In some cases, your borrower may try to negotiate for lower interest rates in exchange for a secured promissory note. The collateral provided by the borrower reduces your risk, allowing you to offer more favorable loan terms.
A car loan agreement, a mortgage contract, or a business loan with equipment as collateral are all examples of a secured promissory note.
How to Write a Secured Promissory Note
Step 1: Determine the Collateral
Choose collateral that is of equal value to the principal amount being offered. For instance, if you are offering a loan of $200,000, a ten-year-old used sedan may not be enough to serve as collateral. The asset should be appraised by an expert or compared to prices of similar items on the market to determine its value.
Examples of collateral include:
- Car, boat, or other motor vehicles;
- Insurance policies;
- Expensive jewelry and artwork;
- Future paychecks.
When you take out a business loan or a home mortgage loan, the collateral generally tends to be the property you intend to purchase with the loan. For instance, if you default on your mortgage, the bank can repossess your home.
When determining what collateral to secure the loan with, consider the following:
- The condition of the asset (i.e., in good condition, maintenance required, depreciation);
- The market desirability of the asset (i.e., level of demand, investors’ interests);
- Ease of title transfer (i.e., liens, transfer procedures);
- The market’s level of activity (i.e., stability of demand, degree of volatility).
Step 2: Secure the Asset
By signing a Uniform Commercial Code (UCC) financing statement, you can secure the asset used as collateral. This statement includes information about both parties, contact details, and a description of the asset. It is governed by the UCC, which regulates all commercial transactions in the United States.
Additionally, draft a separate security agreement specifying the collateral’s terms, the lender’s rights in case of default, and the steps to follow for resolution. This legally binding contract reinforces the asset’s role as collateral, protecting both lender and borrower in the event of default and providing a clear framework for resolving any issues.
Step 3: Outline the Terms
You should also outline the following details about the loan and how the borrower will pay you back:
- Principal amount. This is the total amount of money borrowed.
- Payment schedule. Establish whether the borrower will pay in installments, on-demand, or lump sum.
- Late fee. State whether the borrower will have to pay an additional fee if they don’t pay on time.
- Prepayment. State whether the borrower can repay the loan early without extra charges.
- Acceleration. Establish whether the lender can ask the borrower to repay the whole loan at once, regardless of the original payment schedule.
- Consequences. State what happens if the borrower can’t repay the loan, including the lender’s right to seize and sell the collateral.
- Description of collateral. Detail the specific asset or property pledged by the borrower as security for the loan.
Review the note carefully once all details are outlined. Failure to include any key terms may affect the note’s enforceability.
Step 4: Sign, Exchange Funds, and Store Note Securely
Finally, both parties should sign the secured promissory note. This allows the document to be legally binding and secures both parties in the event that the other defaults. The agreed-upon funds should be exchanged once the note is signed.
Both the lender (with the original) and the borrower (with a copy) should store the secured promissory note until the borrower fully repays the loan and is released by the lender.
Secured vs. Unsecured
An unsecured promissory note is essentially a promissory note without collateral. It risks non-repayment due to lack of borrower’s obligation towards any asset; therefore, it is mostly used for small loans or loans to trusted borrowers, like a friend or a family member.
Secured promissory notes, on the other hand, offer lenders the safety of collateral in case of default but necessitate handling asset evaluation and potential sale.
Secured Promissory Note Sample
Download our free secured promissory note template, which we make available in PDF and Word formats.
SECURED 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)
☐ Other: ______________
☐ This Note shall NOT be payable in installments.
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.
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.
Borrower Signature: ________________________
Borrower Full Name: ________________________
Guarantor Signature: ________________________
Guarantor Full Name: ________________________
Lender Signature: ________________________
Lender Full Name: ________________________
Frequently Asked Questions
To enforce a secured promissory note and repossess collateral, the lender notifies the borrower of default, initiates legal action, and obtains a court judgment. Subsequently, the lender requests a writ of possession and seizes the collateral in compliance with relevant laws and regulations.
For more detailed information, read our article on how to enforce a promissory note.
No, they are distinct legal documents serving different purposes.
A secured promissory note outlines the loan’s terms and includes collateral. At the same time, a security agreement establishes the asset as collateral for the loan, providing additional legal protection for the lender.
Both parties must sign a separate security agreement that specifies the collateral pledged by the borrower to secure the loan. The security agreement outlines the terms of the collateral and the lender’s rights in case of default, providing legal protection for the lender.
Make sure to fill out a UCC financing statement as well.
No, a secured promissory note is not a lien, but it can create a lien. A secured promissory note outlines the borrower’s obligations to repay the loan with collateral as a guarantee, while a lien is the lender’s legal right to acquire the borrower’s asset or property.