Using a Promissory Note for a Car Sale

If you want to sell a car, you may encounter an interested buyer who doesn’t have all the funds upfront. Instead of searching for a buyer with all the cash on hand, you may write a promissory note for a car loan. This arrangement creates a written promise, letting the buyer promise they’ll pay you a specified amount in installment payments or by a specific date.

You can think of this document as a legally binding IOU. It acts as a certification that the buyer bought the car and promises to eventually pay for it in full. As a car seller, using a promissory note protects you by ensuring you receive payment. If the buyer defaults, this document lets you pursue legal recourse. Equip yourself with the knowledge to effectively use a promissory note and protect your car sale.

What Is a Promissory Note for a Car?

A promissory note for a car loan is a legal contract between the car seller and buyer in which the buyer agrees to terms for the car’s repayment. It specifies the principal amount due, repayment schedule, interest rate, security for the seller, and additional details to make the terms of the sale concrete.

From a seller’s perspective, this legally binding document is significant because it:

• Guarantees repayment legally
• Creates a safer, more efficient initial transaction
• Is used as a reference on an ongoing basis to elicit on-time, accurate payments from the buyer and enforce late or missed payment penalties.

Who Needs a Promissory Note for a Car?

The parties that need a promissory note for a car sale include the following:

• Dealerships: Independent or small car dealerships that offer in-house financing might use promissory notes to reduce their risk during car sales where the customer doesn’t pay the entire amount upfront. This financing tool is especially common if the dealership traditionally serves customers with low credit scores who might not qualify for conventional loans.
• Auction houses: Some car auctioneers may use this document when selling collector or high-value vehicles, allowing the buyer to arrange the full payment.
• Private sellers: Promissory notes can help private sellers avoid or address issues with underqualified buyers, as their customer qualification methods may not be as stringent upfront as those of a larger organization selling multiple cars.
• Friends or family members: Friends or family members may sell their vehicles using unsecured promissory notes instead of secured promissory notes because they have established relationships with the buyers.

Car Promissory Note vs. Vehicle Bill of Sale

A car promissory note and a vehicle bill of sale are both important documents involved in the sale or transfer of a vehicle, but they serve different purposes:

• Purpose:
  • Car promissory note: Outlines the terms and conditions of a buyer and seller’s loan agreement when the buyer doesn’t pay the full purchase price upfront.
  • Vehicle bill of sale: Proves that the vehicle sale took place.
• Contents:
  • Car promissory note: Contains financial information relating to the repayment, including the borrowed amount (principal), interest rate (if applicable), the repayment schedule, the consequences of late payments, and the final payment’s due date.
  • Vehicle bill of sale: Features more information about the car itself, including a vehicle description, the vehicle’s condition, a vehicle identification number (VIN), and an odometer reading. It also includes payment details, but a car promissory note expands upon the payment terms.
• Benefits:
  • Car promissory note: Enforces payment terms over time and prevents misunderstandings with the buyer.
  • Vehicle bill of sale: Proves the transaction took place according to terms that both the buyer and seller agree upon.
• Use cases:
  • Car promissory note: Only required when a seller is willing to finance a car and the buyer is willing to accumulate car debt instead of making a lump-sum payment.
  • Vehicle bill of sale: Some states require bills of sale for cars to go to a new owner. Sixteen states require these documents to complete a car sale [1] .
• Legal standing:
  • Car promissory note: This document is legally binding and requires the buyer to repay the seller according to its terms. If it’s a secured promissory note, the seller may be able to seize the car if the buyer doesn’t fulfill their payment obligations.
  • Vehicle bill of sale: This document is legally binding and acts as transaction evidence. It doesn’t serve as the final proof of car ownership, as that is the purpose of a vehicle title.

Benefits of Car Promissory Notes

Explore some of the advantages of car promissory notes for sellers:

Payment Assurance

A promissory note creates a legally binding agreement that the buyer will pay the seller a specific amount, either in installments or a lump sum. It protects the seller, ensuring they create a clear obligation for the buyer to commit to paying.

The Option for Legal Recourse

If the borrower defaults on their payments, the seller can use the promissory note to pursue compensation. The document clearly outlines the agreed-upon terms, so a court of law may be more likely to rule in the seller’s favor if it sees the expectations the buyer fails to meet.

Flexibility with Payment Terms

Sellers can adjust the promissory note’s payment terms to fit their preferences and the buyer’s capabilities. They can set a reasonable interest rate, a manageable payment schedule, and fair late fees, providing clarity for both parties.

Greater Pool of Borrowers

Promissory notes allow for payment over time, which makes them a more appealing payment method. Sellers may be able to expand their pool of potential borrowers when they use this payment option.

Proof of the Financial Transaction

A promissory note is a formal record of the vehicle sale’s financial aspects, as it details the amount owed, the interest rate, and the repayment schedule. Both the borrower and seller can store this document in their records and reference it if future disputes arise.

Simplicity

This financing option is usually simple and easy for sellers to complete in comparison to other legal agreements and financing options. It’s very accessible and cost-effective for private or first-time sellers.

Potential for Interest Earnings

Even though the seller won’t initially receive the full payment amount, they can earn additional money from the transaction by including an interest rate in the promissory note.

Filling Out a Car Promissory Note: A Guide for Sellers

Step 1 – Gather the Necessary Information

Gather information like the buyer’s full name, address, and contact information upfront so you can get in touch with them if any issues occur. You will also need to discuss the terms of the loan first, considering your own needs and the buyer’s financial status and repayment capabilities.

Step 2 – Include the Loan Terms

Essential terms of a basic vehicle promissory note include the following:

• The principal amount: The principal amount is the sum the buyer owes the seller before interest. As the seller, you should require the buyer to make a sizable enough down payment upfront that you can depend on their ability to pay the full amount over time. Subtract the down payment from the total amount you’ve agreed to sell the car to calculate the principal amount.
• Interest rate: The interest rate is the percentage the seller charges the buyer on the total amount of money they borrow over a certain period. It represents the cost of borrowing money.
• Repayment terms: Structure repayment schedules to protect your interests. Choose a repayment period during which you can afford to be at a loss. Decide on payment frequencies and due dates that work well for both parties’ financial needs.
• Security: Add a security clause that protects your asset, using clear language to ensure its enforceability. In the security clause, state that the car acts as security for the loan and that you legally possess the vehicle until the buyer pays the loan in full. In this clause, you can also outline the legal repercussions of loan default, such as car repossession.

Step 3 – Indicate Collateral and Early Payoff Clauses (If Any)

If the buyer can’t pay a suitable down payment upfront, you may decide to protect the sale with collateral. In this case, you can write in the promissory note that you can take a specific valuable asset or set of assets like property or stocks from the buyer if they default on the loan.

You can also protect your projected interest income with an early payoff clause, which incurs a penalty if the buyer pays down or pays off the loan too quickly. Decide on a specific period of time in which this clause will be in effect and note that time constraint in the promissory note.

Step 4 – Include Signatures and Date

The promissory note comes into effect once both parties sign and date it.

Actions for When a Buyer Defaults

Here are some actions you can take if a buyer defaults on their car promissory note:

• Communicate. Reach out to the buyer to confirm that they know they’ve defaulted. You may be able to negotiate a grace period or a new payment plan. Sometimes, a simple reminder of the original terms may be enough to encourage them to make their payments.
• Send a Demand Letter. You may send a demand letter to compel the buyer to pay. In your letter, describe the nature of the default and how the buyer can cure it.
• Repossess the Vehicle. If you secured the promissory note with the vehicle, you may have the right to repossess it. Ensure you follow local laws for repossession, as you may need to notify the buyer or seek a court order before repossessing a vehicle.
• Pursue Legal Action. You may pursue legal action against the buyer to obtain the owed amount.
• Report the Situation to Credit Bureaus. Report the default to one of the three major credit bureaus, which are TransUnion, Experian, and Equifax. If the bureau finds you’re in the right, the buyer’s credit score may decrease. Please note that this may only be a recourse option if you’re a business or have made prior arrangements to report to credit agencies.
• Negotiate a Settlement. Consider negotiating a settlement in which you ask the buyer to repay a lower amount than the original amount you agreed upon. Even though you may take a loss, you can avoid the time and legal fees that a lawsuit may present.

Car Promissory Note vs. Other Financing Options

Outside of a promissory note, you can use other financing methods to sell a car. Some options include the following:

• Lease-to-own agreements: Lease-to-own agreements allow the buyer to lease the car while they get their financials in order and improve their credit score. Once they do so, they may have the option to purchase the car, depending on the terms.
• Third-party financing: In this option, the buyer owes an outside lender instead of owing you directly. The third-party handles the logistical elements of the loan repayment for both sides.
• Dealer financing: With this loan, the dealership originates the loan to its customers and then sells it to a bank or other third-party financial institution.
• Trade-in arrangements: A trade-in agreement allows the buyer to purchase a new car at a lower price by giving the seller their old car.
• Layaway plans: Using a layaway plan, the buyer pays a down payment to put the car “on hold” and then takes the car later when they return to pay the full amount.
• Escrow services: With escrow, a third party holds the vehicle until a specific condition is met, like the buyer fulfilling a purchase agreement.

The Bottom Line

Issuing a promissory note for a car purchase helps you facilitate a sale and acquire the business of a buyer who may not have all the funds readily available. Ensure you know what to do if a borrower defaults so you don’t lose out on a vehicle purchase.

A well-crafted car promissory note offers a structured and secure method of facilitating vehicle sales, providing clear guidelines and legal recourse, which benefits both parties in private vehicle transactions.

Frequently Asked Questions