The Promissory Note
By Aaron Larson
September, 2003; Last Reviewed Dec. 2010
- What Is A Promissory Note
- Legal Terms
- Potential Pitfalls to Avoid
- Real Estate Loans
- Promissory Note Forms
In it simplest terms, a promissory note is a written promise to repay a loan or debt under specific terms - usually at a stated time, through a specified series of payments, or upon demand.
A promissory note will identify the parties, the amount of the obligation, some form of recitation of the consideration for the obligation (that is, what the debtor received in return for signing the note) and will usually include the terms of repayment, the interest rate which will apply (if any). It may also include an "acceleration clause" which will make the entire amount of the note due if a payment is missed.
Be careful when drafting a promissory note to consider state "usury" laws, the laws defining the maximum interest rate you are allowed to charge. There can be serious civil, and sometimes criminal, consequences for violating usury laws.
Promisor - A promisor is the person who makes a promise. In the context of a promissory note, the promisor is the person who is promising to repay the loan or obligation secured by the note.
Promisee - A promisee is a person to whom a promise is made. In the context of a promissory note, the promisee is the person who is entitled to receive payment for the loan or obligation secured by the note.
Obligor - An obligor is a person who binds oneself to another by contract or legal agreement. In the context of a promisory note, this is another owrd for "promisor".
Obligee - An obligee is a person to whom another is bound by contract or legal agreement. In the context of a promissory note, this is another word for "promisee".
Consideration - This is a legal term for the value received in return for entering into a contract. For a contract to be valid there must ordinarily be "mutual consideration" - value received by both parties to the contract. In the context of a promissory note, the promisor usually obtains consideration in the form of a loan, and the promisee receives consideration in the form of the promise to repay under the terms specified in the note.
Security for the Loan - A promissory note is typically what is called an "unsecured" obligation. This means that in the event that the borrower declares bankruptcy, the debt secured by the note will only be repaid after all debts to "secured creditors" have been paid. Thus, if a loan is large it makes sense to get "security" for the loan - a lien or mortgage against real estate, recognition of the loan on the title to titled property (such as cars and certain boats), or even a "UCC filing" against business inventory for loans given to businesses. If you are lending money through an unsecured promissory note, a good rule of thumb is to never lend any more money than you are prepared to lose. If you are loaning a larger sum, consider consulting with a lawyer to make sure that your promissory note is bulletproof, and to determine how you might secure your note to ensure that you will eventually recover the balance of the loan.
Usury - The term "usury" refers to an unlawfully high interest rate. There can be significant consequences for entering into a "usurious" contract. For example, in some states any interest payment made on an usurious loan is applied to the principal balance of the loan - that is, the law transforms the loan into a "zero interest" loan. Most jurisdictions make usury a criminal offense if the rate is particularly high.
Please note that the mere fact that a bank or credit card company charges a particular interest rate does not mean that an individual can charge a similar rate. Many jurisdictions have different interest rate regulations for individuals than for banks or financial institutions. Individuals are often restricted to charging a lower rate of interest. Check your local laws before setting the interest rate for a promissory note.
Late Fees - As with interest rates, there may be limits which apply to any fees you can charge in the event of late payment. Check your local laws before setting the late fees for a promissory note.
While a promissory note can provide the simplest mechanism to secure a debt, care should be taken if the note relates to a loan for the purchase or improvement of real estate. As such loans may be quite substantial, a mere promissory note may not provide the lender with adequate protection in the event that the promisor defaults.
If you are lending money to help somebody with a real estate transaction, you can usually file a mortgage or lien in order to secure the loan. The lien or mortgage is recorded as a public document, and gives any subsequent purchaser of the real estate notice of the obligation and the fact that it is secured by the real estate. Unless your lien or mortgage is discharged at the time the property is transfered, the new purchaser will take the property "subject to the lien". This provides you with protection in case the borrower goes bankrupt, or if the property is sold.
Many office supply stores sell "fill in the blanks" form mortgages. For larger loans, you may wish to seek assistance from a lawyer to make sure that all documents and forms are in proper form and are properly filed and recorded with the Register of Deeds.
As with mortgage forms, you will often be able to find state-specific promissory note forms at an office supply store. These forms often include instruction, including information about maximum allowable interest rates. Please be aware that the instructions may be out of date.
There are also numerous websites that will allow you to purchase and download a promissory note form. Please be certain that the note you purchase online is specific to your jurisdiction before making your purchase.
You may review a sample promissory note form on this website. Please note that it is provided merely as an example, and may not be in a suitable form for your jurisdiction.
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