Promissory Note for Personal Loan: A Comprehensive Guide

Promissory notes serve as binding legal agreements between lenders and borrowers, making them an ideal vehicle to lend money for personal reasons.

With a promissory note, the terms of the loan are documented, which means that both parties know exactly what to expect when it comes to repayment, interest, and any other concerns that may arise.

Before you use a promissory note for a personal loan, make sure you understand the potential legal implications and how the loan may impact you. 

Understanding Promissory Notes

A promissory note is a legal document that lays out the terms of a loan. It formalizes a borrower’s promise to repay a loan and the conditions under which the borrower makes or must issue that repayment.

With a promissory note in hand, both borrower and lender know exactly what to expect from the process, which means that repayment will often go much more smoothly. 

► READ MORE: Types of Promissory Notes

How Promissory Notes Work

Promissory notes are pivotal in personal loan agreements. They detail the terms of a loan so that neither party has any questions about it, including the repayment schedule and terms.

Furthermore, a promissory note secures the lender’s interests by legalizing the terms of the loan. It may spell out specific consequences if the buyer defaults on the loan or any collateral used to secure the loan. 

Having a promissory note also protects both parties’ legal interests as they move forward with the loan process. While the lender can seek legal assistance if the borrower fails to pay back the funds promptly, the borrower can insist that the lender adhere to the terms of the promissory note, including not seeking repayment before the time laid out in the document. 

Friends and Family

Suppose, for example, that you have a friend or family member who needs a personal loan to help during a hard time. You might choose to issue a personal loan at a lower interest rate than the bank. 

Using a promissory note not only offers you legal recourse if your friend or family member does not pay, but it also lays out more specific terms than a handshake agreement, which means that both of you have a better idea of when the loan will be taken care of.

► READ MORE: Lending Money to Family and Friends: Should You Do It?

How to Write a Personal Loan Promissory Note

When writing a comprehensive and legally binding promissory note for personal loans, make sure you are clear and specific in all of your terms and conditions. You want to create a document that lays out expectations on both sides and provides protection to both the borrower and lender. 

Step 1 – Include All Relevant Information

Any time you want to craft a legal contract, it’s important to ensure that the document contains all the essential details. By laying out all the information in the contract, you ensure that there are no loopholes that could cause problems later.

Spell out all relevant details, and do not leave anything out, including:

• Date of Issue: The date when the promissory note is written.
• Amount of Loan: The principal amount being borrowed.
• Parties Involved: The names and addresses of the borrower and lender.

• Repayment Terms: The schedule for repayment, including the due date and any installment details.
• Interest Rate: If applicable, the interest rate charged on the loan.
• Security/Collateral: If the loan is secured, details of the collateral.

If there are questions, hash them out before you sign the contract, and include the answers in writing.

Step 2 – Determine Whether the Document Is Negotiable

A negotiable promissory note can be transferred or sold to another party. The other party can use the promissory note much like they would cash or any other investment, and they can transfer it at any time.

In the case of a personal loan between two parties, on the other hand, promissory notes are often non-negotiable: that is, they cannot be transferred, and only the party named in the document has the right to collect on the loan. 

► READ MORE: Is a Promissory Note a Negotiable Instrument?

Step 3 – Get Signatures From All Parties Involved

To legalize a promissory note, you should have signatures from both borrower and lender. In cases where more than one party will bear responsibility for the loan, make sure to include both signatures. 

Key Features of a Promissory Note

A promissory note will contain several essential features. 

• The amount borrowed: This is the initial amount of the loan, with no interest rates or other details added in. 
• Interest rates: If the borrower will pay interest on the loan, make sure the amount is included in the contract. 
• Repayment schedule: In cases where the borrower pays at specific times agreed upon. State whether payments are due all at once or over time. Note the date of anticipated repayment. 
• Late fees: State whether a late fee is required if the borrower fails to pay on time.
• Consequences for default: Consequences could, for example, include property put up as collateral for the loan and when the lender can take possession of it if the borrower does not follow through on their obligations. 
• Loan security: Whether the loan is secured or unsecured.

Those elements clearly stated can protect both the borrower and the lender in case of a potential dispute.

Legal Implications and Enforcement

If the borrower defaults on the loan, lenders may have legal options for seeking reimbursement. First, they should submit a request directly to the borrower. After that, they may turn to a collections agency or file a lawsuit to recover the funds specified in the document. 

If the loan was secured, the lender may also have the right to seize the property put up as collateral if the borrower defaults. Clear documentation of the loan and its terms can make it much easier to collect since the courts consider the promissory note a legally binding document. 

Transferability and Assignability

In a negotiable promissory note, the lender has the right to transfer, or assign, the right to collect on the loan to a third party. Transferring the loan would absolve the initial lender of the need to collect on the loan, shifting that right to another party. 

A lender might, for example, choose to sell the note to a third party to collect the funds from the loan earlier than anticipated. Selling the loan would provide them with the funds they need immediately. 

The borrower would then pay the new holder of the promissory note. In the case of a promissory note with payment on demand, selling the note could result in the note being called due earlier than anticipated.

In the case of a note with a set repayment schedule or date, however, the new holder of the note would need to hold to the initial terms of the loan. 

Parties Involved

A promissory note is typically a contractual agreement between two parties – a borrower and a lender. The lender will provide the borrower with the amount listed in the promissory note and collect on the note at the predetermined time. 

The borrower promises to repay the lender based on the terms of the promissory note. That may include payments over time, or it may mean that the borrower is responsible for repaying the full amount of the loan at a time named by the lender. 

Interest Rates and Payment Terms

There are several ways to structure interest rates and payments for a personal loan. The promissory note should lay out expectations for repayment so that both parties will understand what is expected of them.

Fixed Versus Variable Interest Rates

Setting interest rates is often complicated. While the banks may have an average interest rate they assign for personal loans, a private loan may have interest rates determined by the borrower and lender. 

Fixed interest rates are set at the time the loan is issued and remain the same for the duration of the loan. Variable interest rates, on the other hand, are changed or revisited at predetermined times throughout the loan’s lifetime and are often based on current market norms.

Repayment Terms

There are several strategies used to determine repayment terms. The one you choose may depend on the duration of the loan, payment amount, or even on the party to whom you are issuing the loan.

• Lump sum repayments are made all at once, at the end of the loan. 
• Installment payments are made over time, rather than requiring the borrower to come up with the full amount of the loan all at once. 
• If the promissory note is due on demand, the lender must repay the borrower immediately, when requested. 

Accrued interest

Accrued interest is determined by multiplying the loan’s outstanding balance by the interest rate and compounding it daily or monthly, thus increasing the total debt. This interest is added to the loan’s principal, raising the amount due.

Signing and Storing a Promissory Note

By carefully considering the legal requirements for signing and the best practices for storage, lenders and borrowers can safeguard the enforceability and accessibility of promissory notes.

Signing Requirements

Witness Requirements – The necessity for witnesses or notarization can vary depending on the jurisdiction. While not all states require a witness or notary for a promissory note to be enforceable, having a notarized document can add a layer of verification and legal validity.

State-Specific Requirements – Some states may have specific requirements regarding the execution of promissory notes, such as the need for certain disclosures to be included within the note or specific wording. It is important to consult legal advice to ensure compliance with local laws.

Secure Storage of Promissory Notes

Physical Storage – Keep the original signed document in a secure, fireproof, and waterproof location, such as a safe or safety deposit box. Ensure that both parties have copies of the signed note, but the original should be kept with the lender or in a mutually agreed-upon secure location.

Digital Storage – Scanning and storing a digital copy of the note can be a practical step for backup. Use encrypted digital storage solutions to protect the document from unauthorized access. Cloud storage services offer convenient access but ensure they comply with security standards and provide adequate privacy protections.

Access – Whether stored physically or digitally, the storage method should ensure that authorized parties can access the document when needed without compromising security. Establish clear procedures for retrieving the note, especially if stored in a safety deposit box or through a digital platform that requires password access.

Enforceability – The content of the note, such as the amount borrowed, interest rate, repayment schedule, and any collateral, should be clearly stated. Regular updates or amendments to the note should be signed and stored following the same protocols as the original.

The Consequences of Default in Personal Loan Promissory Notes

The consequences of defaulting on a loan laid out by a promissory note can, in many cases, be the same as when a borrower defaults on any other type of loan. The lender may decide to:

• Work with a collection agency to recover the funds laid out in the loan. A collection agency may take possession of the note or pursue the funds for the lender. 
• File a lawsuit against the borrower. Filing a lawsuit can, in some cases, help the lender recover any outstanding balance. 
• Collect any collateral laid out in the loan agreement. 

If the lender does take the loan to collections or file a lawsuit, it can have a significant impact on the borrower, including a decrease in their credit score. The borrower may also face financial repercussions for failing to repay the loan, including wage garnishment.

Alternatives to Promissory Notes

If you choose not to move forward with a promissory note, there are other strategies you can use to secure a personal loan. You might, for example, choose to use a simpler loan agreement, which might contain fewer terms or lack the ability to transfer it to another party.

Others may choose to provide collateral, which the lender would hold until the borrower returns the loan amount. While these strategies may prove beneficial, a promissory note offers a higher overall degree of legal protection.

Wrap-Up

The terms laid out in a promissory note protect both the borrower and the lender, ensuring that their financial futures remain as secure as possible and increasing the odds that both sides will adhere to the terms of the loan.

Laying out those legal terms, from the payment schedule to the date it comes due, is essential for protecting both parties. Before you sign a promissory note as either a borrower or lender, make sure you have a strong understanding of the terms and what they will mean for you.