What is a promissory note? Parts, types, and when you need one
A promissory note is the simplest serious loan document there is: one person promises, in writing, to pay another a specific amount on specific terms, and signs it. That one page is what turns "I'll pay you back" into a debt a court will enforce.
The parties
The borrower, also called the maker, signs the note and promises to pay. The lender, called the payee, is the person to be paid. Whoever has the right to enforce the note at a given moment is the holder, usually the lender, but a note can be sold or assigned to someone else. See who holds the original note.
What a note has to say
- Names of the borrower and lender.
- The principal: the exact amount borrowed.
- Interest: the rate, stated as an annual percentage, or that there is none. See choosing an interest rate.
- Repayment terms: payment amount and schedule, or that it's due on demand, and the final due date.
- Default terms: late fees, what counts as default, and what happens then.
- The borrower's signature and the date.
Optional but common: collateral, prepayment terms, a co-signer, and a choice of governing state law. See how to write a promissory note.
The four common types
- Secured: backed by collateral, such as a car or equipment, that the lender can claim if the borrower defaults. See secured vs unsecured.
- Unsecured: backed only by the borrower's promise.
- Installment: repaid in regular payments on a schedule.
- Demand: repaid when the lender asks, after any notice period the note sets. See demand vs installment.
These combine. A loan to buy a car from a relative is often a secured installment note.
Note, IOU, or loan agreement
An IOU acknowledges a debt but usually leaves out the repayment terms, which makes it weak evidence. A loan agreement is longer and puts obligations on both sides. A promissory note sits between them: short, one-directional, and enforceable on its own. See promissory note vs IOU vs loan agreement.
Is it enforceable?
A properly signed note is a binding contract. If the borrower stops paying, the lender can sue on the note, often in small claims court for smaller amounts, within the state's statute of limitations. Notarization is rarely required, but it makes the signature harder to dispute. See is a promissory note legally binding and notarization and witnesses.
When you should have one
Any time you lend money you expect back: to family or friends, to a business partner, to a buyer under seller financing, or against collateral. The amount where it becomes worth writing down is lower than most people think. If losing it would sour the relationship, write the note.