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A promissory note is used when one party, the issuer, is making a "promise" to pay a certain amount of money to another party, known as the payee.

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Promissory Note: What Is It?

A promissory note is a legal document related to financial information. This is a promise in writing, so it is legally binding. The promissory note may detail the repayment conditions or it may be open-ended.

This promissory note, also sometimes called a note payable or just a note, should include the principal amount of money, the interest rate, and the specific terms of repayment. The payee's rights in case of a default are usually outlined. Promissory notes are typically used for personal loans, real estate transactions, business loans, and student loans.

The 6 Key Components of a Promissory Note

A “promissory note” is essentially what it sounds like – a note of promise. It is a legal document enforcing an unconditional promise on the part of a borrower, or “payor,” to repay funds to a lender, or “payee.” As legal documents go, a promissory note is fairly simple. In business, financial and real estate sectors, it often accompanies a larger document such as a loan contract. The longer document contains most of the gory details and legalese, while the promissory note serves as a summary. Key components of the promissory note spectrum include mortgage notes, bank notes, and commercial papers.  A promissory note may also contract a small loan between friends or acquaintances - sort of as one step up from an IOU. Large or small, a promissory note has six key components:

Use of the term “promissory note” – In a way, this is the most crucial of a promissory note’s key components – the word “promissory note” must appear in order for the document to legally be one. The simplest way is to use the term in the header, and in the opening recitals of the agreement.

Identities of both parties – The document must include the full legal names and, addresses, of the payor and the payee. This information often appears in the introduction:

“For value received, the undersigned Sam Spam (the “Payor”) of 123 Cockaminy Road, Nontown, NonState, 00005 hereby promises to pay to the order of Joe Schmoe (the “Payee”) of 456 Minacocky Road, Townless, NotaState, 50000…”




“I, Sam Spam (the “Payor”) of 123 Cockaminy Road, Nontown, Nonstate, 00005 hereby promise to pay Joe Schmoe (the “Payee”) of 456 Minacocky Road, Townless, NotaState, 50000….”

Terms – Promissory notes are not by and large detailed documents.. However, a straight-up overview of the loan terms is key. Components of a promissory note’s terms section should include:

·         Amount of loan, or “principal.”

·         Interest.

·         Terms of repayment. These include the date the loan was made, the date full payment is due, and if the payor is paying in installments, the required dates/rate of repayments and installment amount(s). For example:

“The first payment, in the amount of $700, must be paid by April 3rd, 2014. The second payment, in the amount of $900, must be paid by June 5 th , 2014. The third and final payment, in the amount of $300, must be paid by July 25 th , 2014.”


 “The first payment in the amount of $40, must be paid by September 12 th 2014 and on the same date each month hereafter until the full amount is repaid, on or by December 12 th 2014.”

Penalties . The payor may be penalized for late payments, defaulting, or violating any other terms of the note. Fees for late payments and other minor infractions often take the form of added interest:

“If a payment is skipped or delayed, .06% interest will be added to the initial interest.”

However, if a payor defaults on a loan, the penalty tends to be more severe. In the case of large loans, it may involve collateral of a valuable asset, such as a house or a car. The purpose of collateral is to ensure that the payee receives fair repayment. For this reason, a loan’s collateral should compare in value to the amount due.

A promissory note that comes with collateral is called a “secured promissory note.”

Security agreement - This is not a key component of the promissory note itself, but rather an additional document attached to a secured promissory note. This agreement describes the payor’s collateral asset(s).

“The Payor agrees that until the aforementioned principal and interest are paid in full, this note will be secured by [collateral property].”

An “unsecured promissory note” has no security agreement, and the payor’s pledge carries no collateral. The only guarantee of full repayment is the payor’s signature. In the case of a default, the payee may sue the payor, but as this often proves financially counterproductive (as lawsuits cost a pretty penny), many payees opt to settle rather than sue.

Signatures  - No document can be considered legal without authorization. A promissory note must bear the signatures and signing dates of the payor and a notary public, and in the case of an unsecure promissory note, the payee.

Legal Considerations of Signing a Promissory Note

Putting your signature on anything is a serious matter, never to be taken lightly.  If you're being asked to sign a promissory note, you might think that it's not a big deal and that you should just go ahead and sign it.  However, you should know that there are legal considerations that you'll definitely want to keep in mind, both before and after you sign it.  Being aware of these considerations will help you protect your legal rights as well as fulfill your responsibilities.

The best way to start is with the basics: what is a promissory note form?  In essence, it is a legal instrument in which a payer attests that he or she will remit a specified sum of money to a recipient or payee on or before a certain date.  Unless otherwise noted, this will be an unconditional promise and must be paid or else there will be penalties under the law.  It's a bit like an IOU, except it is more formalized and is certainly more enforceable.  It can be used for many situations, from business transactions to promises of payment between friends or family members. A promissory note is essentially a legally binding "IOU" note.

A legal consideration that applies to just about any document is that one should read it fully and carefully before signing it.  In the case of a promissory note, there are things to look for when reading it.  Examples of this would be the due dates for payment and whether the payment must be made in a lump sum or if there are provisions for partial payments to be made.  Equally significant are the financial penalties that would be incurred if payments are late; you'll want to check to see how much interest would need to be paid, if any.  Note that there are usury laws that specify the maximum interest rates for the repayment of a debt, and no one has the right to ask you to pay any interest rate above and beyond what the law indicates.

Another thing you'll want to check for is what's known as an acceleration clause, which may or may not be included in the document.  This is a provision that would require the payer to remit the entire amount owed if any payment is missed.  If you are not comfortable with this stipulation, you might choose not to sign the form.

Yet another legal consideration is the validity of the promissory note template.  Are you absolutely sure that you're signing a form that is worded correctly?  An improperly written document can certainly cause problems later on.  To ensure that it is written correctly, you as the payer may wish to help the payee compose the document.  This is not difficult to do nowadays, since the Internet makes it easy to search for just about any type of form you could possibly need.  Try searching for a free promissory note on a search engine, or if you prefer a fillable form that can be modified, try searching for a free promissory note template.  For most situations, a simple promissory note is all you need, so look for a form that is brief and easy to understand.

The bottom line is that you need to understand the legal aspects of any form before you attach your signature to it, and a promissory note is no exception to that rule.  Any lack of due consideration could have dire consequences, such as owing more money than you really ought to, or worse yet, ending up in a legal dispute.  Protect your rights and your money by doing your due diligence, asking questions if you're unsure about anything, and educating yourself as much as possible.

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