It is common to find ourselves in situations where we loan money to someone or borrow money. In the past, a simple handshake would seal the deal. Today, more security is needed for the transaction — you never know the individual you are lending money to. In most cases, the best protection for these transactions is a promissory note. It helps you keep track of the transaction and avoid any irregularities.
What Is a Promissory Note?
Sometimes referred to as a note payable, a promissory note is a legal document in which individual promises in writing to pay a certain amount of money. It can either be at a determinable or fixed time and under agreed terms.
Types of Promissory Notes
There are two major types of promissory notes, these are:
Secured promissory Note: This is an obligation to pay backed up or secured by some property. It means that failure to pay, the loaner can seize the property in compensation for the loan.
Unsecured promissory Note: This is an obligation for payment without any property securing the payment. In case the payer fails to pay, the loaner must file a lawsuit against them. This is the only way of getting compensation.
When to Use a Promissory Note
There is a wide range of cases when a promissory note is used. For instance, it is used for student loans, mortgages, business loans, car loans, and personal loans between friends and family. If you are lending a lot of money to an individual, it is prudent that you create a promissory note to secure the transaction. It protects your funds and ensures that you are repaid on time.
How to Write a Promissory Note
When writing a promissory note, you should include the following details:
1. Full names of parties (borrower and lender)
The promissory note should begin with the mention of full names of the borrower and the lender. Both parties are advised to sign the note even though the borrower’s signature is the most important.
2. Repayment amount (principal and interest)
The promissory note should indicate the principal amount (total money borrowed) and the amount to be paid back. You should also indicate whether you are charging interest (clarify whether it is compounded monthly or annually) or not.
3. Payment plan
You need to indicate how the money will be paid back. For instance, you should show the loan’s due date, commonly known as the maturity date. If the loan is to be paid in installments, state whether it is weekly, monthly, or yearly. You should also indicate the amount for each installment.
4. Consequences of non-payment plan (default & collection)
In case the borrower fails to settle the loan, the lender can take action against them. They can demand full payment of the loan or collect on the collateral. In case of legal action, promissory notes are strong evidence against the borrower.
5. Notarization (if necessary)
Typically, you don’t have to notarize a promissory note. However, it is important always to check your state laws to verify the witness requirements and signature.
Common Key Terms and Clauses in Promissory Note
There are a few common key terms and clauses that are necessary to be included in the promissory note. These include:
Allocation of payments: This describes how the borrower shall make payments in relation to interest.
Prepayment: This clause indicates the rules of settling the loan early, be it individual payments or the entire loan.
Acceleration: The lender can demand immediate loan payment if a borrower breaches the terms of the agreement.
Attorney’s Fees and Costs: If loan defaulting involves court cases, the borrower must incur all the fees and costs.
Waiver of Presentments: It is a clause that shows the lender doesn’t have to demand payment when the loan is due. It is the responsibility of the borrower to ensure that the payment is made on time.
Non-Waiver: If the lender delays or fails to exercise their rights under the promissory note agreement, it doesn’t mean that they are waiving their rights.
How to Do Calculations
The following methods can be used to do calculations in the process:
Total interest owed: To calculate the total interest owed, multiply the money borrowed by the annual interest rate.
The final payment amount: To determine the final payment amount, add the money borrowed to the total interest owed.
The monthly payment amount: The monthly payment amount is determined by adding the money borrowed to the total interest owed. After that, divide the figure by the number of months required to pay the loan.
Some Tax Benefits of a Promissory Note
You might want to document whether the money you are being issued is a loan or a gift — this helps in filing for taxes or accounting. For example, you might be allowed to give a gift of $10,000 to each of your family members without any gift tax consequences. Each year, your parents could provide a total of $20,000 to each of their grandchildren every year to reduce the estate taxes.
Free Promissory Note Templates
Promissory notes form an essential part of any transaction. If you lend money to an individual, it is necessary to secure the transaction with a promissory note. Use our templates to create a detailed note for easier transactions. You can download the promissory note templates and customize them to your preferences.
Templates by State
In conclusion, a promissory note is an essential document in any business transaction. It is more crucial when court cases are involved. Use our templates to create a detailed promissory note.