A promissory note is a document that records a promise to pay back money that has been loaned by one person to another. The party making the promise to repay is known as the debtor or the maker of the note. The party loaning the money is called the creditor or the holder of the note. Promissory notes are created when a loan is made, in order to record the promise to repay the loan.
The legal effect of a promissory note is similar to that of a contract, in that the debtor is legally bound to hold to their promise as recorded in the note. A default, or failure to make payments can result in several unwanted consequences such as a lawsuit, bad credit, or repossession of a home or other property.
A thoroughly written promissory note should include:
- Amount of repayment
- Terms of repayment
- Amount of interest charged
- What will happen in the case of default
Promissory notes are most commonly used in for mortgages and trust deeds in connection with residential property transactions.
There are several different types of promissory notes, depending on the type of loan that was issued.The different kinds of promissory notes include:
- Personal Promissory Notes: These are used to document a personal loan from a friend or family member. Although many people tend to avoid legal writings when dealing with trusted acquaintances, the use of a promissory note actually demonstrates good faith and effort on behalf of the borrower.
- Commercial: Promissory notes are almost always a requirement when dealing with commercial lenders such as a bank. Most commercial promissory notes are similar to personal notes, although they can be stricter. If the borrower defaults, the commercial lender is usually entitled to immediate repayment on the balance. Further, default can result in a lien on the borrower’s property in order to obtain payments.
- Real Estate: These are similar to commercial notes with respects to the default consequences. In this case, a lien is placed on the home or other real property. If default on a mortgage results in a lien, the information becomes public record and can affect the borrowers credit or purchasing abilities in the future.
- Investments: In a business setting, promissory notes are sometimes exchanged in order to raise capital for the business. This type of note may be a type of security interest and would thus be regulated by securities laws. These notes often contain clauses dealing with returns of investment for a certain time period.
Promissory notes are useful and necessary tools that are beneficial for both the lender and the borrower. With a promissory note, the lender gains additional assurance that their loan will be repaid in a timely and legitimate manner. For the borrower, the note can provide important information regarding his or her rights.
Promissory notes are legally binding documents, even if they are considered to be negotiable. Negotiable simply means that the document may be altered by a later agreement, and changes must usually be enforced by further monetary consideration. Defaulting on a promissory note can result in serious consequences, especially if there is an acceleration clause included.
When a borrower defaults on a promissory note that includes a acceleration clause by missing a payment, the entire amount of the loan will be due no matter what the initial term of the repayment.
If a borrower defaults on a promissory note by failing to make a payment on time, the holder of the promissory note may give notice of the default to the borrower and if the past due payment is not paid, the holder can file an action to collect the entire balance of the note plus any interest due.
Finally, failure to fulfill a promise recorded in a promissory note can result in poor credit scores. Violations can even effect child custody rights, particularly in the case of repeated or habitual defaults.
Anytime a loan is made, it should be recorded in a promissory note. Whether you are the lender or the borrower, you should work with a lawyer, who will help you draft and review the written instrument. If you have defaulted on a promissory note, an attorney can help you determine if any defenses are available. If you are a lender and the borrower has defaulted on a loan, your lawyer can discuss your options for recovering damages. Present your case to a real estate lawyer now.