Promissory Note Tips - When You Should Have One

What is a Promissory Note?

You’ve heard the term IOU, which acknowledges a debt. The promissory note takes things a step further and contains a promise to pay back the debt.

When executed properly, a promissory note is a legally enforceable document. Even if you’re loaning money to a family member or friend, it’s a good idea to record the terms of the loan agreement. Ideally this should occur at the time the money is loaned.

The loan agreement is a separate legal document that contains all of the terms and conditions of the loan contract. A promissory note provides evidence of the loan.

Promissory Note Tips – Identify the Parties

In order to be enforceable, the body of the document must include legal names, addresses, and phone numbers of all parties involved in the transaction:

Maker is the one borrowing money
Payee is the one to whom money is owed

Here’s how it works. The maker promises in writing to pay a specified amount of money to the payee, typically on a fixed date. Sometimes the payee requests a “due on demand” option. Payment is then due at a future date to be determined by the payee.

Promissory Note Tips – Outline the Terms

In the note, agreed upon terms of repayment must be outlined, including:

Loan principle, or the original amount borrowed
Interest rate (if applicable)
Maturity date, or date the loan becomes due

Rules vary from state to state, but a promissory note must always be signed by the borrower. Some states require a signature from the payee as well as the maker. Others require a witness, though it’s prudent to have a notary acknowledge all signatures.

I’ve notarized several promissory notes in the six-figure range, always with both parties present and signing the document.

Promissory Note Tips – Payment Options

There are several options for structuring repayment, the most common being lump sum. In this case the payee receives a single payment on a specified date or upon demand.

Payments can also be structured to include interest, but this is not required by law. If interest is included, there are state laws limiting the percentages that may be charged. Many people do not charge interest on loans to friends and family members.

Secured vs Unsecured Promissory Note

Unsecured notes are typically reserved for a borrower with high net worth and an excellent credit history. Most lenders prefer secured notes, which involve collateral and a security agreement. This is for the protection of the payee, who can legally seize collateral if the terms of a promissory note are not carried out.

Promissory Note Tips – Default Terms

Sometimes provisions are included to outline the payee’s rights in the event of a default; that is, if the maker fails to pay the loan in accordance with the agreed upon terms.

A secured promissory note should include a statement to this effect: “Whereas the borrower has entered into a security agreement dated April 12, 2013 as collateral for the loan.” This connects the security agreement to the promissory note.

Default of payments on debts covered by a secured promissory note require the borrower to forfeit the specified collateral in lieu of payment.

Right to Transfer Clause

In some cases the payee requests a right to transfer clause. When this happens, the borrower has a right know up front. If the clause is exercised, the note is transferred by the lender to another party. The original terms of the promissory note agreement would remain in effect.

Helpful Links

Statute of Limitations on Promissory Notes in California.

Promissory Notes for Personal Loans to Family and Friends.

Promissory Note Forms

Adams Promissory Note Forms and Easy to Understand Instructions Written by the Legal Editors of NOLO

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