Loans

Promissory Note Loan: Pros + Cons

There are many loan options out there, and most of them come with a promissory note. A promissory note is a legally binding document that has loan details on there, specifically related to repayment. A lender will provide this to their borrower, and with a signature, the borrower promises that they will do everything they can to repay the loan in accordance with the terms and conditions provided on the note.

Chances are if you have taken a loan from a financial institution before, you likely signed a promissory note as part of the paperwork. You can also add a promissory loan when giving out or borrowing money from a friend or family member. 

However, you may not know precisely what is on there and whether it is a good idea to have a promissory note in the first place. Before signing up for anything, it will be essential to know about some of the pros and cons, along with exactly what you are signing up for. Continue reading to learn more about promissory notes and promissory note loans.

What Is Included in a Promissory Note?

Because a promissory note involves two parties, the lender and borrower, it will have information about both. It essentially stipulates what is a part of the loan agreement. Here is what you will see on it: 

  • Personal information on both the lender and borrower, including their names, addresses, and phone numbers. 
  • The total loan amount agreed upon. 
  • The amount of interest that is a part of the loan.
  • List of collateral if applicable. Along with the terms that the borrower agrees to, including forfeiting the asset if the contract is broken.
  • The duration, amount, and frequency of the payments.
  • The default terms. 
  • An acceleration clause.
  • Information on collection costs
  • To make the note legally binding, both parties will have to sign it.

Things You Should Pay Extra Attention to With Your Promissory Note

There are some critical aspects of a promissory note to pay attention to as a borrower, including the repayment schedule, to ensure that you aren’t breaking any rules. Here are some of the common ways that loans are repaid and will likely be listed on your promissory note:

A Lump Sum Payment

Sometimes, a loan must be repaid in one single lump sum payment. If that is the case, it will be extra important to know exactly how much is due and when. 

Details on the Interest Rate and Interest Payments 

If there is any type of interest on a loan, you will know about it in the promissory note. In most cases, you will see a percentage for the total interest rate or APR, which you can use to calculate how much interest you will pay on a monthly basis/as a part of your monthly payment. 

Due-on-demand

This is common with friends and family; a due-on-demand payment means a borrower must repay the loan when the lender asks for the funds. 

Installment Loan Payment

Installment payments are the most common type of repayment for a loan. With this option, you would pay back the loan in equal monthly payments

The Different Kinds of Promissory Notes

On a basic level, there is an unsecured promissory note, which does not include an asset as a form of payment, and a secured promissory note, which uses an asset as a form of payment. 

Expanding on that, there are a few different types of promissory notes out there. The kind you will see will depend on the type of loan you are taking out and the lender you are working with: 

Commercial Promissory Notes

Commercial promissory notes are the most common type you will see as a consumer when you go to lenders or financial institutions to borrow money. For example, a credit card or personal loan will usually have a commercial promissory note with them.

A standard commercial promissory notes is usually used for installment payments, while these other commercial note options will be available depending on the repayment type: 

Simple Promissory Note

A simple promissory note is usually present when there is a lump sum payment. 

An Open-ended Promissory Note

An open-ended promissory note is usually used for lines of credit/revolving credit. 

Informal Promissory Notes

These types of notes are common when lending or borrowing from friends and family members. Usually, a handwritten or typed-up note that is still legally binding but is more relaxed than if you were conducting business with a financial institution. 

A Demand Promissory Note 

A demand promissory note can be used for loan contracts with on-demand payments. To collect from this option, a lender can send a Demand for Payment Letter, which is a letter that asks for payment.  

Real Estate Promissory Notes

You will see this next type of promissory note when financing a home or property through a mortgage loan. The loan will have a real estate promissory note. It is imperative to pay attention to the details of this note and loan agreement closely because failure to follow instructions could mean losing the property!  

Corporate or Convertible Promissory Notes

Businesses that owe money, but cannot pay it back right away, may issue a corporate promissory note, also sometimes referred to as a convertible promissory note. These notes can be converted to equity in a business as well. 

Investment Promissory Notes

Investment promissory notes are given to investors from businesses/companies trying to raise capital. These investors usually take a risk, but if their investment pays off and the company is worth a reasonable amount, they can sell that promissory note to other investors. As a commercial borrower, you will likely not have to worry about these promissory notes. 

What Kinds of Loans Are Considered Promissory Note Loans?

Any loan that has a promissory note with it can be considered a promissory note loan; here are some examples of loans that usually have this built-in: 

Student Loans

Student loans usually come with commercial promissory notes. When taking out multiple federal student loans, there will be a master promissory note for all of them. In most cases, student loan repayment will start after you graduate. 

A Mortgage Loan

A mortgage loan helps finance a home or secondary property. A real estate promissory note will be included with the paperwork on the loan. Because mortgages are highly complicated, you may not see all the terms and exact conditions on the promissory note, but your mortgage loan officer will let you know where you can find those details. 

A Personal Loan

A personal loan is one of the most common loan options out there. With a personal loan, you will often see a commercial promissory note. Repayment for a personal loan will include accrued interest and the principal amount repaid in regular monthly installments. 

Some Advantages of a Promissory Note Loan

There are definitely advantages of having a promissory note loan for both borrowers and lenders. Here are some of the benefits of this legal document: 

  • It sets clear guidelines for what the loan agreement is asking for. 
  • It can be reassuring/ add extra security for the lender that they will get their money back. 
  • Promissory notes can be fairly easy to make up on your own. If you are looking for a free promissory note template, there are many online. For more detailed notes, or if you don’t want to do it alone, you can pay an attorney to draft one out for you. 
  • You can use a promissory note when lending money to friends or family. It can be a great form of security and formalize things a little more. 
  • A promissory note is legally stronger than a verbal agreement or an informal IOU. 
  • If you are a borrower it can be a good reference if you forget when your debt is owed, the monthly payment amount, and how your payments are due on your loan. 

Some Disadvantages of a Promissory Note Loan

There are also some disadvantages to using a promissory note; here are some examples: 

  • A promissory note can add a false sense of security for the lender. Even though it is a legally binding written agreement, it does not guarantee repayment! 
  • A promissory note can become complicated quickly, and you may need to have an attorney or even a legal team working on it, depending on the loan. This can cost a lot of money, depending on the work involved. 
  • Legal issues can arise in some states if the note isn’t notarized. 
  • Loans that only have a promissory note and no loan contract may not hold up legally if questioned. 

A Loan Contract vs. A Promissory Note

A loan does not always need to have a loan contract and a promissory note. But when borrowing from a financial institution, you will likely see both. A loan contract will have much more detail about the loan, and can be legally stronger than just a note. It is always a good idea to review it just like you would with a promissory note. You can reference your loan contract if you need to double-check anything on a promissory note. 

References:
What Is a Promissory Note? – Experian
Promissory Notes: What They Are & How They Work | Lantern by SoFi