A promissory note is a legal document that guarantees a specified payment amount from one party to another. It’s also sometimes referred to as a note payable.
What is a Promissory Note?
A promissory note is just as binding as a traditional loan. However, it is often used for informal agreements like a loan between friends. A promissory note contains detailed repayment terms, including the loan amount, maturity date, and interest rate. Both contracted parties must also sign the promissory note to enforce it in court.
A promissory note is very similar to a bill of exchange. Nontraditional lenders often use a promissory note. In contrast, financial institutions typically use a bill of exchange in commerce. Both are governed by the 1930 Geneva Convention of Uniform Law on Bills of Exchange and Promissory Notes.
If conducting business with a financial institution, a promissory note is provided. But suppose you are doing business with a family member or friend. In that case, either party could obtain a promissory note from a financial professional or lawyer. However, a witness is not necessary for a promissory note.
Does a Promissory Note Require Collateral?
If both parties agree to the terms, a lender can request collateral. An asset can secure a promissory note. There are both secured and unsecured promissory note options available.
A secured promissory note will usually come attached with a secondary document. Suppose a personal item is used as collateral by a borrower. In that case, a security agreement form will also need to be presented with the promissory note.
Under the terms of the security agreement form, the lender can decide if the borrower can physically keep the asset until the Debt is repaid. Suppose the conditions of the promissory note are not met by the maturity date. In that case, the lender can seize the borrower’s assets.
What Are the Different Types of Promissory Notes?
There are a couple of different types of promissory notes lenders can use. The type of promissory note used will depend on the repayment terms.
- Simple Promissory Note: A simple promissory note is used when the debt is paid back in one lump sum on a specific date.
- Demand Promissory Note: This type of promissory note does not have a due date. Payment of the debt is expected when the lender demands the money. However, the borrower must be given sufficient notice to come up with the money.
- Secured Promissory Note: This type of promissory note requires the use of collateral. Physical items and intangible items, such as copyrights, can be used to secure funding. If the borrower does not adhere to the repayment terms, the lender can seize the asset.
- Unsecured Promissory Note: This type of promissory note does not require the use of collateral.
What if a Promissory Note Goes Unpaid?
A lender may take legal action if a borrower does not offer payment by the maturity date of the promissory note or does not provide the asset. First, a demand letter must be sent by an attorney on behalf of the lender. The demand letter will request a specific action, such as payment of the promissory note.
A collection agency can file a debt collection lawsuit against the borrower if the borrower doesn’t take action after receiving the demand letter. The borrower will have to respond to the lawsuit and appear in court.
If the borrower does not appear in court by the summons date, the court will likely favor the lender. In addition to the agreed-upon debt listed on the promissory note, the court may order the borrower to pay additional fees for interest, Collection costs, and attorney fees. The debt collector will withdraw the total loan amount plus fees from the borrower’s wages or bank account.
Will an Unpaid Promissory Note Affect Credit?
If a borrower does not comply with the promissory note, is their credit score negatively affected? The answer is yes. A lender can choose to report the missing payment to one of the three credit bureaus: Equifax, Experian, and TransUnion.
Note that not just anyone can negatively report an individual to a credit bureau. If you and a friend signed a promissory note, which goes unpaid, your friend could not report you and vice versa. Lenders must be registered as an official lending authority and pay to report information.
Registered creditors can report a promissory note default. A promissory note default is just as damaging as a standard loan default. It will appear on the borrower’s credit report and lower a credit score. Negative information will stay on a credit report for seven years, such as loan Default. After seven years, any unfavorable information is removed from a credit report.