Promissory Note

Financial Dictionary -> Loans -> Promissory Note

A Promissory Note, (different from an IOU, which is just an acknowledgement of a debt), is a contractual document that one person gives to another as an unconditional promise to pay them a sum of money. It will be agreed that the issuer will pay the money by a certain date or on demand of the payee, meaning they can ask for payment at anytime with only a few days notice. This is called a Demand promissory note.

There are certain terms that will be included in the note that state the amount owed or to be paid, the people involved, the interest rate if it's applicable and the date of maturity if it isn't a demand promissory note. For promissory notes to be legal they need to follow usury laws, which is the law that defines the maximum amount of interest rate that can be charged.

Promissory notes are usually unsecured and play second fiddle to secured loans like mortgages etc. If the promisor defaults on other loans, goes through the foreclosure process or is declared bankrupt all other secured loans will get what is owed to them before the promissory note agreement is fulfilled. It is not always easy to secure a promissory note so don't loan anything you can't financially lose.

Promissory notes are generally used on a more personal level when borrowing from relatives or friends and aren't used by banks or financial institutions. For larger sums of money it is safer to take out a lien and if it is real estate related a mortgage should be used.

If legal issues occur the presentation of a professionally worded and signed promissory note should be enough to prove the loan exists. It is a good idea to contact a lawyer to help you draft one up.