Let's imagine for a minute that you want to borrow $10,000 from your aunt to purchase a car. After the initial shock wears off, she agrees to loan you the money. But before she gives you the cash, your aunt wants the specific repayment terms spelled out in writing and signed by both parties. This document is considered a promissory note and is a legally binding contract. No matter where you go or what you do with the money, your Aunt can always prove that you owe her the money.
The History of the Promissory Note
The promissory note has changed very little over time and the concept of the promissory note has more than likely been around since the beginning of money. Historically, promissory notes have acted as a form of privately issued currency. The first evidence of a promissory note being issued is that which issued in Spain in 1553.
Promissory Note Defined
A promissory note form (or legal document) is a detailed and written personal promise to repay money to somebody else. Promissory Notes differ from IOUs in that they contain a specific promise to pay, rather than simply acknowledging that a debt exists. A personal IOU may acknowledge that a debt exists, but the specific repayment details may not be included.
A promissory note is a simple agreement. Often referred to as a note payable in accounting, or commonly as just a "note", a Promissory Note is a negotiable instrument, wherein one party (the maker or issuer) makes an unconditional promise in writing to pay a certain sum of money to the other party (the payee), either at a fixed date in time or on demand of the payee with specific terms such as interest rates and collateral.
How can a Promissory Note be used?
A promissory note can be used to create a legal and binding agreement when lending money or even financing the sale of personal items and real property. A promissory note’s payment can be scheduled to fit your specific needs and requirements. It's a matter of simply setting out the terms and conditions of the loan in an “unsecured promissory note” or a secured promissory note.
Important things to consider are:
How much is going to be loaned the amount of interest and rate (if any at all) The rate of repayment you wish to schedule 9i.e. monthly, quarterly, etc.) And the security interest also called collateral.
You can even have the entire amount become due and payable on a certain date. A promissory note should be drafted in plain English so that you can insert the specific terms and conditions and understand the entire contents of the document.
Misconceptions about Promissory Notes
There are a few borrowers who believe that a promissory note which is signed and dated with a private person lender is somehow much less enforceable than say a promissory note signed with a bank. This is completely untrue! There is absolutely no difference whatsoever in the enforceability of a promissory note no matter whom the lender is, and this is an important thing to remember. Once the promissory note is duly signed and dated it is legally binding, and the failure of a borrower to perform under the terms and conditions of the promissory note is legal grounds for default and foreclosure of the loan.
The Functions of a Promissory Note
The functionality of a promissory note is to outline in detail the specific amount and terms of a loan and in addition, to provide signed evidence of the receipt of the loan proceeds, and the actual commitment by the borrower to repay the loan completely. In the case of a commercial bank loan, the promissory note will also include a detailed "repayment amortization schedule" and will outline the total amount of interest including the principal payments over the life of the loan.
A properly worded and signed promissory note is usually enough to prevail in any legal proceeding against the borrower, but there are some exceptions. Companies such as One2One Lendingoffer an inexpensive, easy to use website to help create a legally binding contract. If the borrower can prove he or she signed the document under extreme duress, meaning under undue pressure from the lender, then a judge may rule the note unenforceable. The borrower must sign a completed document, not merely place his or her signature at the bottom of a blank page. A promissory note should not contain conditions which would be considered illegal elsewhere, such as an impossibly high interest rate or additional penalties that are not spelled out in writing.
