What is this Promissory Note for?

Student Loan

A student loan is a loan made by a financial institution or private party to someone who wants to return to school. The promissory note lists the amount provided to the student and the terms of repayment. It is often signed by both the lender and the person receiving the funds.

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Personal Loan

A personal loan is a loan made to someone by a financial institution or another person so that the recipient can use the money for a use that's not always specified to the lender. Generally, the loan is used for "personal" reasons which is how the loan name is derived. A promissory note outlines the amount provided to the recipient as a personal loan and the terms of repayment. Promissory notes for personal loans are signed by both the lender and the recipient.

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Business Loan

A business loan is money provided by a lender, venture capitalist, or even a private party to help someone grow their business. The money is earmarked specifically for business use. A promissory note explains the purpose of the money, the amount that was provided, and the terms of repayment. A promissory note is signed by both the lender and the recipient. Sometimes, a promissory note for a business loan will contain a personal guaranty that assures the lender that the recipient will repay the loan even if something happens to the business.

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Real Estate Purchase

A real estate purchase is often recorded in a promissory note. It will describe the property, the names of the parties involved in the purchase, the amount of the purchase, and the terms of repayment. Many promissory notes for real estate purchases are state specific. So, in addition to both parties signing the promissory note, you want to ensure you've met all the legal requirements in your state to document the real estate sale.

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Vehicle Purchase

A vehicle purchase is one of the most well-known uses of promissory notes. It is used if a car will be financed by a lender, a private party, or from a "tote the note" car lot. The promissory note will describe the vehicle, the amount of the sale, and the terms of repayment. The promissory note is often signed by the person agreeing to pay for the vehicle.

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Other

Because a promissory note outlines the terms of a sale that is essentially being made because someone promises to pay for the item over time, it can be used for almost any sale. Regardless of what is sold, you should include a description of the item, the date the sale occurred, the price of the item, and the terms of repayment. Depending on the item sold, the promissory note may need to be signed by one or both parties.

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What is a Promissory Note?

A promissory note is a legal document related to short-term loans and loan payments. This is a promise in writing. When it contains certain elements specific to the state in which it is created, it is legally binding. It may detail the repayment conditions or it may be open-ended.

A promissory note form is also referred to as a note payable or just a note. As a negotiable instrument, it should include the amount of money (the amount given to the person promising to pay it back), the interest rate, and the specific terms of repayment. The payee's rights in the event of a default are usually outlined. A promissory note form is typically used for personal loans, to loan money, real estate transactions, business loans, and student loans.

The Essential Guide to Promissory Notes

Introduction

This is a guide designed to help readers navigate all of life’s situations that involve promissory notes. What follows is a detailed overview explaining what it is, what distinguishes one from similar agreements for outstanding debt, when and why you should use one, the different types of notes, and what to include in one. Our hope is that this guide provides a “one-stop shop” for any situation that needs or may benefit from a its use.

Legal considerations of signing a promissory note

Putting your signature on anything is a serious matter.  It should never to be taken lightly. If you're being asked to sign a promissory note, you might think it's no big deal to just sign it. However, you should know that there are legal considerations you should keep in mind before and after you sign it. Being aware of these considerations will help you protect your legal rights and fulfill your responsibilities.

The best way to understand the legal ramifications of what happens if you must sign one is to start with the basics: what is a promissory note? In essence, it is a legal instrument where the payer (sometimes referred to as the borrower) promises they will pay a certain amount of money to a recipient (known as the payee or the lender) on or before a certain date. Unless otherwise noted, it is an unconditional promise. This means that it must be paid or a demand note could be issued and the lender might hire a debt collector or consider suing you for the money. A promissory note is a bit like an IOU, except it is more formal and is more easily enforced. It can be used in many situations, from business transactions to promises of payment for a loan from friends or family members.

Although creating one is relatively simple, it’s important to read it before signing it. There are specific things to look for when reading it. Pay attention to the specific dates for payments and whether any payment will need to be a lump sum. Equally significant are the financial penalties of late or missed payments. You'll want to check the interest rate as well. Usury laws in your state specify the maximum interest rates for the repayment of a debt. No one has the right to ask you to pay any interest rate above and beyond what the law indicates.

Look for an acceleration clause. While it’s not always used, you’ll want to ensure that you read it if it is present. This is a provision that requires the payer to pay the entire amount owed if even one payment is missed. If you are not comfortable with this, you should consider not signing the note.

Validity of the promissory note template is also an important legal consideration. Are you absolutely sure that what you're signing is worded correctly? An improperly written document can certainly cause legal problems later on. To ensure that it is written correctly, you, as the payer, may wish to help the payee compose the document or you may both choose to get legal advice from a law firm.

How Does a Promissory Note Differ from Similar Documents?

Promissory Notes versus IOU or Loan Contract
  1. An IOU is an informal written note between a borrower and a lender. The lender promises to pay the amount loaned to them by the lender.
  2. A loan contract is a written contract between a borrower and lender promising the repayment of a loan by the borrower to the lender. However, it typically involves complex repayment and interest terms, fee structures, one or more interest rates and payment amounts, a maturity date, and legal remedies for the lender if the borrower doesn't pay.

In terms of formality and legality, a promissory note lies somewhere between the other two documents. It offers more details, is more complex, and has more information than an IOU, but it is not as complex as a loan contract.

When and why do you use a promissory note?

There are a multitude of situations in which a promissory note is useful. Some of those include:

  1. Lending or borrowing a large sum of money.
  2. Taking out a student loan.
  3. Avoiding a bank note or loan agreement because of credit score, employment status, etc.
  4. Wanting something more formal than an IOU.
  5. Wanting something more flexible than a loan agreement.

Why Have a Promissory Note?

Promissory notes protect both the borrowers and the lenders.

  • For lenders, they legally ensure loan repayment and provide legal remedies if the borrower stops paying. They can help you avoid lawyer fees for recovering money owed, to demand payment, or to contest ownership of property. Additionally, they may also help you avoid the expensive IRS gift tax of 40%.
  • For borrowers, they act as proof of purchase and ownership if the note involves the exchange of property; it potentially enables you to avoid paying taxes on the loan (or “gift”); and it allows you to avoid expensive lawyer fees if a legal dispute over payment or property.

Promissory notes give peace of mind and legal documentation of a financial relationship between two people. When it is issued between friends or family, the peace of mind and safety provided can potentially protect relationships by clearly explaining processes and legal options if there is a dispute, late payment, or default.

Why not just go to a bank?

A promissory note is not always a better alternative to a traditional bank loan (sometimes called commercial papers). However, in certain situations it may be more desirable. Consider the following when deciding between a promissory note and a traditional bank loan.

  1. The borrower’s credit score. Bad credit can result in paying a higher interest rate or prevent borrowers from qualifying for a bank loan altogether.
  2. Promissory notes allow anyone to become a lender.
  3. Promissory notes allow for a borrower/lender arrangement that is more flexible.
  4. A promissory notes allows for creativity on repayment options, interest rates, etc.

How to pay or collect on a promissory note

Types of Repayment

The borrower should repay the note according to the terms of the note. There are four basic types of repayment:

  1. Installment plan: Regular payments (e.g. monthly) of equal amounts, typically including principal and interest, are made until the loan is repaid.
  2. Installment plan with balloon payment: The borrower agrees to make regular payments (e.g. monthly) at a typically low-interest rate for a period of time (e.g. two years). At the conclusion of that timeframe, the borrower has the option of re-paying the remainder of the loan in a single balloon payment or refinancing the remainder of the loan, typically at a higher interest rate.
  3. Lump sum payment by a specified date: Commonly used for smaller loan amounts, the borrower agrees to repay the lender by a certain date (e.g. “The Borrower shall repay the lender $1,000 at 5% interest, or $1050, within one-year of the issue of the loan).
  4. Due on demand: Most commonly used between family and close-friends. Due on demand does not outline a timeline for repayment. The borrower is required to repay the lender at their own discretion, in regular or irregular installments, a lump sum, etc.

Secured and Unsecured Promissory Notes

Promissory notes are often categorized or classified as “secured” or “unsecured.” The difference is whether there is collateral. If the borrower offers collateral as security for loan repayment, the note is considered “secured”; if no collateral is required, the note is “unsecured.”

What is a master promissory note?

Student loans require what’s called a Master Promissory Note (MPN). This is a legal document where a borrower (i.e. the student) agrees to repay a given loan, along with any interest and fees, to the U.S. Department of Education. The MPN also outlines the terms and conditions of the issued loan.

Unless prohibited by the school, students can take out multiple federal loans under, or add additional loans to, one MPN during a ten-year period. There are different MPNs for different categories of student loan borrowers:

  1. Eligible undergraduate students and eligible graduate/professional students requesting unsubsidized loans should use the Subsidized/Unsubsidized Master Promissory Note.
  2. Graduate/professional students who do not qualify for unsubsidized loans and wish to apply for a PLUS loan should use the Graduate/Professional PLUS Master Promissory Note.
  3. Eligible parents of eligible dependent undergraduate students requesting a PLUS loan should use the PLUS Master Promissory Note for Parents.

Conclusion

Whether you're considering lending money to a friend or loved one and would like to document the agreement, you’re looking to borrow a sum of money without going through a bank, or you're a college student (or parent of one) sorting out what exactly a Master Promissory Note entails, this guide should provide you with all of the information you need to decide if this sort of agreement is best for you. Remember to read the note (in its entirety) and ask questions (or get legal advice) if you don't understand the contents before you sign it.

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