As you might have already guessed from the self-explanatory name, a promissory note – colloquially known as an IOU – is a legal contract between two individuals that details the fine points of a promise to repay a personal loan.
Promissory notes are used to formalize and document loans that do not involve a financial institution, such as the type of lending that typically occurs between family members, friends or even strangers. Both parties benefit from drafting this legally binding document as it helps the lender feel protected, which in turn renders it more likely that the borrower receives the loan.
To learn more about how a promissory note works, when to use one, how to write one using our template and more, read on below.
Are Promissory Notes Legally Enforceable?
Yes, a promissory note is legally enforceable. Although it cannot guarantee a lender receiving his or her money back in full, a promissory note will function as a valuable piece of evidence – as is the case with any contract – in the event you have to take the borrower to court.
Even from a non-legal standpoint, a promissory note also yields pragmatic benefits for negotiations. Firstly, the document acts as a useful reference point in keeping both parties on the same page as it explicitly and clearly delineates all the specific terms of the loan agreement. This clarifies any ambiguities that might arise between the borrower and lender, reducing the likelihood of a he-said-she-said argument.
Secondly, having agreements of any kind drafted on an official document encourages the involved parties to follow-through in general. In other words, even if you never have to go as far as to use the note in court, the potential ability to do so increases the borrower’s dedication to comply with the repayment terms.
When & How To Use a Promissory Note
A promissory note ultimately works to protect the lender, so they should be the party making the decision about whether or not to use one. In coming to this conclusion, there are three issues in particular that you must make sure to consider.
- Is it a significant amount of money?Determine how much the amount in question means to you. If a friend is borrowing 20 bucks, then obviously there’s no need to formalize the transaction in a legal document. However, if the amount of money is substantial, then drafting a promissory note is definitely the safest way to go.
- Are you willing to take the borrower to court if you are not repaid? If not, would a promissory note still help or hurt?Depending on your relationship with the borrower, you may or may not actually be willing to use the courts to garner repayment. For example, most people won’t make their parents sign a promissory note in order to borrow money, but they might ask that of a friend or business contact and be willing to legislatively collect.So, if you would take the borrower to court in seek of repayment, then you should absolutely draft a promissory note. If you would not be willing to go to court, ask yourself if having a note would still be helpful – would it subconsciously encourage repayment or inadvertently damage an important relationship? If drafting a promissory note helps more than it hurts, then you still consider creating one even if you’ll never use it in court.
- How complex are the loan terms?If a loan’s terms are not basic, perhaps involving collateral or equity in a corporation, then a promissory note might not be suitable to your needs. A more advanced type of legal agreement as well as the guidance of an attorney might be preferable in such situations.
If you decide that drafting a promissory note is the best way to go, feel free to follow our WalletHub template below as a guideline. In doing so, make sure to print two copies of the contract – one for borrower and one for the lender – and have parties sign both copies.
Additionally, to avoid potential future disputes regarding the authenticity of the promissory note, you can opt to have witnesses present for the signing as well as having the promissory note officially notarized.
Avoiding Promissory Note Fraud
Unfortunately, there are instances of promissory note fraud out there – in fact, the industry is worth tens of millions of dollars. These scams typically occur more often with strangers and acquaintances on a business level – such as with independent insurance agents – rather than with individuals we know well.
In these situations, the “maker” of the promissory note will approach individuals and ask them to lend money to a particular borrower. They often market the pitch as a business investment that will produce substantial long-term returns. However, once the money is transferred, the fraudsters elope with the funds or spend it on a Ponzi scheme to sustain the process.
Because the consequences are often extremely costly, we recommend completely avoiding promissory notes from people you don’t know. However, if you are interested in vetting a particular opportunity, here are some of our tips for recognizing and avoiding scams:
- Out of Place: Authentic business promissory notes are rarely marketed to the general public. They are usually sold privately to expert and/or corporate buyers who complete their own thorough background research. Hence, if a random individual attempts to sell you a promissory note, you should avoid the temptation as you are probably being scammed.
- False Security: If a note labels the returns as “insured” or “guaranteed,” it is often done so to create a pretense of safety. Most of the time, the insurers either don’t exist or exist exclusively offshore and cannot offer insurance within the United States. Therefore, do not fall for notes that appear overly secure.
- Investment Transparency: It is extremely important that you know exactly where any money you lend is going and how it will be used. It’s easy to conceptualize how your sibling who is starting a business will put the money to work for example, but the tactics a friend of a friend is using to “kill the market” might be a lot less clear. In general, the more you know about a given business opportunity, the less likely you are to fall for a scam.
- Suspicious Returns: If the note promises returns that are unusually higher than the current market rate, such as double-digit returns, then you should resist the temptation to commit. Fraudulent notes often bait investors with these types of rates in order to draw their attention away from double-checking the legitimacy of the terms.
- Unlicensed Agents: Avoid sellers that are not licensed. Insurance agents are prohibited from selling securities, such as promissory notes, without having registered for a securities license first.
- Pushy Sellers: Proceed with caution towards sellers who are overly assertive and hurried. If they are, it is most likely because they are being offered an abnormally high commission -- as high as 30% in stark contrast to the usual 3%-5% -- and this is often a sign of promissory note fraud.
Free Promissory Note Template
Drafting a legal document can be difficult and tedious. That is why, even though we at WalletHub are not lawyers, we thoroughly researched and compared promissory notes in order to create the best sample for you. Feel free to follow our customizable template to create your own promissory note. You can either copy and paste the template from below, or download the PDF version.
| Borrower: | Enter Borrower’s Full Name |
| Info | Enter Borrower’s Date of Birth |
| Info | Enter Borrower’s Street Address |
| Info | Enter Borrower’s City, State & Zip Code |
| Lender: | Enter Lender’s Full Name |
| Info | Enter Lender’s Date of Birth |
| Info | Enter Lender’s Street Address |
| Info | Enter Lender’s City, State & Zip Code |
| Witness (Optional): | Enter Witness’s Full Name |
| Info | Enter Witness’s Date of Birth |
| Info | Enter Witness’s Street Address |
| Info | Enter Witness’s City, State & Zip Code |
| $ Enter Monetary Value Borrowed | Enter Date Created |
- Promise to PayThe Borrower agrees and promises to pay the Lender the principal amount of $ Enter Monetary Value Borrowed, in addition to the accrued interest specified in Section II, and if applicable, the additional costs specified in Section V, in full accordance with all the terms listed below.
- InterestThe unpaid principal amount will accrue payable interest at the rate of Enter Annual Interest Rate % per annum.
- Payment Logistics
- Mode Of PaymentAll payments from the Borrower to the Lender will be made in the form of Enter Cash/Checks/Money Transfers, to the order of Enter Payment Details (Ex. Account Number) .
- Schedule Of PaymentThe amount owed under this Promissory Note – including the principal amount and accrued interest – are to be repaid in equal installments of $ Enter Amount To Be Repaid Per Installment on a Enter Weekly/Monthly/Yearly basis, beginning on the Enter Date Of First Payment; Each following payment will be made on or before the day of Enter Day Of Week/Day Of Month/Day Of Year of each Enter Week/Month/Year until the amount owed is paid off in full.
- Additional Costs
- Default ExpensesIn the event the Borrower defaults on his or her payments, the Borrower is responsible for paying the additional costs to cover the expenses of collection, including but not limited to attorney fees and collection agency fees.
- Late Payment FeesIn the event that the Borrower fails to make his or her payments within Enter Number Of Days days of the proscribed due date, then the Borrower shall pay an additional amount of $ Enter Late Payment Fee as a late payment fee.
- Transfer of Promissory NoteIn the event the Promissory Note is transferred by the Lender to another subsequent holder, the Borrower must remain bound by the terms of the Promissory Note, regardless. Any subsequent holder of this Promissory Note bears the right to legally enforce the terms of this note.
- SuccessorsAll the terms and conditions specified in this agreement shall bind the Borrower’s successors, assigns and heirs – if need be – provided that the Lender gives written consent for the Borrower’s delegation of responsibilities first.
- Breach of Promissory NoteThere can be no breach of the promissory note in any shape or form. No amendments, modifications or waivers regarding the Promissory Note can be put into effect without the written consent of both the Lender and the Borrower.
- Governing LawThis Promissory Note shall be governed by and executed in accordance with the laws of the State of Enter State Name in the United States of America.
- Prepayment The Borrower bears the right to prepay the amount owed in full or in part at any point in time, without any penalty or premium whatsoever.Both the Lender and the Borrower hereby indicate by their signatures and dates below that they have read and are in full agreement with the terms and conditions of this Promissory Note.
Borrower’s Signature: _______________________________ Date: ____________
Lender’s Signature: _______________________________ Date: ____________
This Promissory Note was executed in the presence of Enter Witness’s Full Name, who hereby indicates by his or her signature and date below that they have witnessed this event.
Witness’s Signature: _______________________________ Date: ____________
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