In basic terms, a promissory note is a promise to pay back a loan. The promissory note will lay out the terms of the loan, in case there is a misunderstanding later on. They operate under many of the same rules as standard contracts. A personal promissory note is a note that specifically details the terms of a loan made to family or friends.
Sometimes, loaning money to family members or friends can be a highly sensitive matter. This is especially true if the loan is for a significant amount of money or one of the parties is concerned about their ability to pay back the loan.
You may be more comfortable having something in writing to protect both parties in case there is a disagreement or a misunderstanding regarding the terms of the loan later on.
There are many types of promissory notes, such as commercial promissory notes or real estate promissory notes. Many people may be familiar with the idea of a promissory note if they have taken out a mortgage to buy a home, as this is one of the important documents you must sign at a real estate closing.
While promissory notes are used in a variety of matters, personal promissory notes are often used in situations related to divorce or child support proceedings, in which a friend or family member may need help in financing a lawsuit.
What Information Needs to Be Included in a Personal Promissory Note?
In order for the personal promissory note to be valid and enforceable, there is certain information that needs to be included in the document.
The basic information that should be in the document includes:
- The names of the parties (both the borrower and the lender);
- The loan amount (the total amount that the borrower is borrowing);
- When and how the loan must be repaid;
- Details about repayment schedules; and
- Whether interest will be charged, and how much.
In addition to the basic information, you may also want to include more details about the loan repayment. For example, you may want to state whether the loan will be paid in monthly installments (and how much those installments will be), or whether the loan will be repaid in a full lump sum payment.
These details can be extremely important, since many disputes involve the details of repayment. Many disputes can be avoided by having a well thought-out and detailed repayment plan that both sides understand.
Another thing to consider is whether the loan will be secured by the borrower’s personal property or real estate. This means that if the borrower misses some or all of the payments, the lender can be compensated through a sale or transfer of that property. This is a common scenario in real estate mortgages — if the borrower fails to make their mortgage payments, then the lender can sell the property at foreclosure to get paid.
If you plan to secure the loan with property, you will need additional paperwork. For physical personal property, such as a car, jewelry, or computer equipment, you will need to complete a security agreement along with the promissory note.
A loan secured by real estate will need a mortgage or deed of trust completed with the note. Consulting an attorney is the best way to make sure that you have the proper paperwork completed to secure the loan.
Do I Need to Charge Interest on a Personal Promissory Note?
This can be a particularly sensitive subject, especially since personal promissory notes are used between friend and family. Some may see this as ungenerous, but interest actually has a very important function for loans. Basically, interest is intended to fairly compensate the lender for using money that could have been earning interest somewhere else.
For example, instead of making the loan, you could have invested the same money and earned gains. Additionally, charging interest can be a way to adjust for changing economic factors, including inflation. When loaning small amounts of money to family and friends, this may not be an issue. However, the larger the loan and the longer the repayment period, you may want to consider including interest.
One note about charging interest — most states have laws that cap the interest rates that lenders can charge for loans. This cap is generally somewhere in the range of 10%-20%. While you’re not likely to charge your friends and relatives an exorbitant interest rate, this is unlikely to present a problem. However, if you and the borrower have agreed on an interest rate above 10%, you may want to check your state’s usury laws.
If you do not charge interest on a personal promissory note, there is a possibility that the loan could be legally treated as a gift, especially if the loan is to family. This may not seem like a big deal, but it could have unintended consequences, especially when it comes to taxes. The IRS may impute interest on the loan amounts and require that you report the interest as taxable income.
What if Personal Promissory Notes are Not Honored?
Not honoring a valid promissory note could result in several legal consequences. The most common disputes regarding personal promissory notes have to do with repayment of the loan, specifically missed payments (also known as default).
If a borrower defaults on payment of a personal promissory note, you may file a lawsuit to collect the payments. The court may require the borrower to make up their missed payments, and a failure to do so can result in other legal issues, such as contempt of court charges. If the borrower still cannot make up missed payments even after a court judgment, they may face further consequences.
They may have their property seized by authorities and sold in order to provide the funds for payments. This is especially likely if the loan has been secured by property and the correct security agreements have been filed. A borrower who continuously defaults on personal promissory notes may also lose certain privileges, like those related to child custody or visitation.
Should I Hire a Lawyer if I Am Involved in a Personal Promissory Note Dispute?
If you are involved in a situation where friends or family members are asking to borrow money, and you need help with a personal promissory note, it would be a really good idea to contact a business lawyer. A qualified business lawyer who has experience with promissory notes is a good person to ask for advice, especially if the proposed loan involved a large amount of money.
Your lawyer can help you draft a valid promissory note that will be effective and recognized under the laws of your state, and help you navigate the legal system if you need help to resolve the matter in the courts.