If you’re lending out a large sum of money, you probably want more than just a pinky promise of payback from the person borrowing it.
Individuals and businesses use promissory notes all the time to meditate lending. These notes can be used for anything from mortgages to financing company growth. Find out more about how to use promissory notes in this article and download a template to create your own.
What is a promissory note?
A promissory note is a legal document that acts as a promise to pay. Companies use them as notes payable, a form of debt capital they can use to finance their businesses. They can also be used between family and friends to lend money in a more structured way.
What goes into a promissory note?
Promissory notes always include the borrower’s and lender’s information and signatures, an interest rate, and payment schedule. Secured promissory notes also contain information about a securities, or collateral assets the borrower promises to turn over to the lender in the event that they do not pay back the borrowed amount plus interest. The security acts as an extra precaution, or extra assurance that the lender will be paid back.
Since promissory notes are legal agreements between two parties, they should be tailored to fit both parties’ needs. Download our customizable template and read on for descriptions of what you’ll need to include in your promissory note:
The first section of your promissory note should include the current date and the name and address of both the borrower and lender.
This is pretty straightforward: obviously you need to include information about who is borrowing from whom.
Amount and interest rate
Just below the lender and borrower information and of equal importance is the amount of money being lent and the interest rate to be charged.
This amount and rate must be agreed upon by both parties and be in compliance with state usury laws (laws that dictate the maximum interest rate lenders can charge in each state). According to the Illinois General Assembly, interest rates cannot be higher than 9%—check your state laws to make sure your promissory note complies.
Promissory notes can either be paid in a lump sum (all at once) or installments (periodically).
Either way, the same amount of money plus the same amount of interest is paid back to the lender—the payment schedule is merely a timeline of when the borrower will do it. Typically, the two parties choose weekly, monthly, or quarterly installments. This is also the portion of the promissory note where you can specify a late fee to be charged if the borrower does not adhere to the payment schedule.
In this portion of the promissory note, the borrower and lender decide whether or not the borrower will provide a security, or an asset they own that will be used to pay back the lender in the event that they are not able to pay off their debt by the note’s due date.
This asset, sometimes referred to as collateral, could be anything from a prized painting to a portion of the borrower’s stock portfolio. Whatever it is, it is written on the line shown above, and the promissory note is considered secure.
Signatures are what seals the deal on the promissory note.
Any information above this section must be read carefully, because by signing and printing their names and the date, both the borrower and lender show that they agree to the terms of the promissory note. After a third party witness signs and dates the document, it is finalized.
Keep in mind that promissory notes are legally binding. While in some cases they can be renegotiated, be wary that if borrowers do not comply to the terms, lenders may take legal action. It’s best to play it safe and keep your promises—only borrow money you are sure you can pay back.