Promissory notes are written instruments that record the transaction details for a loan between two parties. They can be used for a variety of transactions, including financial investments, real estate transfers, personal loans, and business loans.
Promissory notes create legally binding obligations between the borrower and the lender. Failure to fulfill the promises recorded in a promissory note can result in lawsuits and other consequences. In order to avoid disputes over promissory notes, it is important to understand the different repayment plans that can be used in such notes. Also, it is helpful to have an attorney draft and review the note to make sure that the note will be legally binding in a court of law if a dispute arises over the note.
It is important to understand what kind of repayment plan you will be using in the promissory note. Both parties should be absolutely clear on how much money is owed and in what manner it is to be repaid. That way, it will be less likely that the borrower will default on a payment due to a misunderstanding of the repayment plan.
Some common forms of repayment schedules are:
- Installment Payments Including Interest: The borrower must pay a defined amount every month over a specific time period. Some of the payments go towards the principal (the loan amount), with the remainder going towards interest. This type of payment plan is common for home, business, and automobile loans. It is frequently called an “amortized payment.”
- “Balloon” Payment: This allows the borrower to pay monthly installment payments followed by a large payment (the “balloon”) at the very end of the loan. Sometimes the lender will allow interest-only payments, which results in lower monthly rates, even though the principal never decreases. In interest-only repayment schedules, the final balloon payment will be the entire principal loan amount plus any remaining interest.
- Lump Sum Payments: The borrower must pay the entire loan amount in one lump sum payment on a specified date. This is usually used for smaller, short-term loans to be repaid within a year. Since the plan only lasts a short period of time, there may be no interest involved.
The type of repayment schedule chosen can have monumental effects on the total amount paid. If you are unsure of which type of payment is ideal for your situation, you may wish to consult with a lawyer for more advice. For example, a balloon-type schedule might be ideal for those starting a small business if they will have many initial start-up costs, but will be earning profit later on as the operations continue.
At the very least, you should be familiar with the language that describes the different actors in a promissory note. Some of these legal terms include:
- Promisor: This is the person who is receiving the loan, and is commonly known as the borrower. They are the ones making the promise to repay according to the repayment schedule.
- Promisee: This is the party or person who is supplying the loan, and is commonly known as the creditor or lender. It is usually a bank or a mortgage company. They will be receiving the payments.
- Obligor: This is the person who is legally bound by the promissory note, and is usually the promisor/borrower.
- Obligee: This is the person to whom the obligor is legally bound, and is usually the promisee/lender.
Finally, you should know what the word “consideration” means. For any agreement to be legally binding, it must be supported by consideration, or something of monetary value to be exchanged between the parties. In the context of a promissory note, the lender receives value from repayments, while the borrower receives value from the loan itself.
If, as a borrower, you are unable to make payments, you should consider requesting to change your repayment schedule. A different type of plan may be more suitable for you and your loan. Most promissory notes are negotiable, which means that they can be changed later on so long as the changes are supported by mutual consideration and agreed upon by all parties.
You should avoid defaulting on a payment at all costs. You could be required to pay the loan off in its entirety for missing payments. Also, the lender is often allowed to place a lien on your property in order to secure funds for missing or late payments.
A competent real estate lawyer can help you draft your promissory note. If there are disputes over repayment schedules, your attorney can help you negotiate to obtain your desired plan. Also, in the event that a lawsuit arises, your lawyer will be available to help argue your claim in a court of law.