A promissory note is a legally binding document, recording a promise in which one party is to repay a specific amount of money to another party in a given time frame. The party making the promise to repay is referred to as the debtor, or, the maker of the note. The party loaning the money is referred to as the creditor, or, the holder of the note. A promissory note is created when a loan is made, in order to record the debtor’s promise to repay the creditor’s loan.
In legal terms, the effect of a promissory note is very similar to a contract, as the debtor is legally bound to uphold their promise as recorded in the note. Failure to make payments could result in a lawsuit, bad credit, or repossession of a home or other property.
In a real estate context, a promissory note commonly addresses repayment of money or loan amounts. With a real estate promissory note, the borrower’s property may be subject to a lien should they default on their payments. An example of this would be how if they fail to repay the agreed-upon amount within the specified time frame, the other party may be allowed to claim ownership of some or all of the listed property through a lien.
What Does a Promissory Note Include? What Are the Different Types of Promissory Notes?
Promissory notes should be thoroughly written in order to avoid conflicts involving the note. Some examples of the common features and elements of promissory notes include:
- Repayment amount;
- Repayment terms;
- The amount of interest charged; and
- What will happen in instances of default.
Promissory notes are most commonly utilized for mortgages, as well as trust deeds connected with residential property transactions. As such, it is imperative that as many specific details as possible are used to make a promissory note.
There are multiple different types of promissory notes. The type of note that is utilized will depend on the specific type of loan that was issued. Some examples of different types of notes include:
- Personal Promissory Notes: This specific type of promissory note is used to document a personal loan from a friend or family member. Although many people try to avoid legal documentation when dealing with trusted acquaintances, the utilization of a promissory note would actually demonstrate good faith and effort on behalf of the borrower. Taking the possibly uncomfortable step of drafting and signing a promissory note could help avoid further discomfort later on, should any issues arise;
- Commercial Promissory Notes: Generally speaking, promissory notes are a requirement when involved with commercial lenders, such as a bank. Most commercial promissory notes are similar to personal notes, although they commonly contain more strict terms to adhere to. If the borrower defaults, the commercial lender is usually entitled to immediate repayment on the balance. Additionally, defaulting could result in a lien on the borrower’s property in order to obtain payments, as previously mentioned;
- Real Estate Promissory Notes: Real estate promissory notes are similar to commercial notes in terms of the default consequences. A lien is placed on the home or other real property; the information becomes public record, and can affect the borrower’s credit or purchasing abilities in the future; and
- Investments Promissory Notes: In a business setting, promissory notes may be exchanged in order to raise capital for the business. As this type of note may be a type of security interest, it would be regulated by securities laws. Such promissory notes commonly contain clauses addressing returns of investment, for a certain time period.
Promissory notes are useful and necessary tools that are considered to be mutually beneficial for both the lender and the borrower. The lender gains additional assurance that their loan will be repaid in a timely and legitimate manner, while the borrower is provided with important information regarding their rights.
Are Promissory Notes Different from Loan Contracts?
Again, promissory notes are considerably similar to loan contracts in several ways. Both documents can create legally binding obligations, which could be met with legal consequences if breached or defaulted upon. However, there are some significant differences, such as:
- Details and Formalities: Promissory notes generally contain fewer details and instructions, in terms of payment amounts and repayment schedules;
- Default Consequences: Contracts commonly contain specific instructions regarding a breach or default, whereas promissory notes might not always contain these points.
- Signatures: A promissory note may only require the signature of the borrower; Contracts, however, generally require the signature of both parties. This is especially true for mortgage loans and similar agreements; and
- Payments: Generally speaking, formal loan contracts demand installation payments, whereas promissory notes tend to have more flexible repayment schedules and terms.
As such, promissory notes are often utilized in situations in which less detailed instructions are acceptable. Because contracts can take a while to develop, and may be revised during negotiations, the overall transaction or loan arrangement may be delayed.
Alternatively, a formal real estate contract may be preferable in situations involving the need for additional instructions, details, or protections relating to the loan. Contracts may also be necessary in situations involving a high risk of fraud, or a high risk of default on the payments. To put it simply, promissory notes are most commonly used in minimal risk circumstances, whereas contracts are generally used for higher risk dealings.
What Happens If I Default on a Promissory Note?
It is important to remember that promissory notes are legally binding documents, even if they are considered to be negotiable in nature. In legal terms, negotiable simply means that the document may be altered by a later agreement; generally, changes must be enforced by further monetary consideration. Defaulting on a promissory note could result in serious consequences, especially if there is an acceleration clause included.
An acceleration clause is a contract term, requiring the borrower to pay off the entire remainder of the loan amount should they default on one or some of the payments. The contract performance is “accelerated;” what this means is that the entire amount becomes due when the agreed upon circumstances are triggered. When a borrower defaults on a promissory note that includes an acceleration clause, the entire amount of the loan will be due no matter the initial terms of repayment.
When the promissory note is not paid, 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 may legally file an action in order to collect the entire balance of the note (plus any interest due). Failure to fulfill a promise recorded in a promissory note could result in poor credit scores. It could also affect child custody rights, specifically when repeated or habitual defaults are involved.
What If I Have a Dispute over a Promissory Note?
One of the most common disputes involving promissory notes stems from the fact that they are considered to be less formal, and contain less detailed instructions. Various conflicts can occur, especially if one of the parties is unclear about a repayment term.
Legal remedies for disputes over promissory notes generally result in a monetary damages award, in order to compensate for economic losses. Other remedies similar to those prescribed for a breach of contract are common, such as the clarification of a term or the creation of a different type of promissory note.
Do I Need a Lawyer for Help with a Promissory Note?
You should consult with a local mortgage lawyer if you need any assistance involving a real estate promissory note. As state laws vary in terms of what conditions allow for a promissory note instead of a contract, an experienced and local real estate attorney would be best suited to understanding your state’s laws and how they may affect your specific circumstances.
Additionally, should you need to file a private civil lawsuit, an experienced attorney can guide you through that process, and help you obtain a proper remedy. An attorney can also represent you in court, as necessary.