What Is A Promissory Note?
A promissory note is a written promise to pay another party a definite sum of money, either on-demand or at a specified future date.
A promissory note documents a legally binding promise that a borrower makes to pay back a loan under specific terms and conditions. Typically, the note contains detailed information about the loan, including the loan amount, interest rates (if any), repayment plan, and collateral security.
A promissory note creates a clear record of a loan between two entities. Putting every relevant detail of a loan in writing ensures both parties are clear on their obligations and expectations.
It is commonly used when an individual or business wants to obtain a loan from non-traditional money lenders like individuals or companies other than a financial institution. However, a financial institution may require a borrower who takes a small personal loan to sign a promissory note.
It is different from a normal contract. Contracts merely spell out all the terms of a legal agreement, while promissory covers:
- When a borrower would pay a lender
- How much a borrower would pay a lender
- How the borrower would pay the lender
It also differs from IOUs. An IOU, abbreviated from the phrase “I owe you,” is merely a document that acknowledges a party owes another party a sum of money.
Usually, a promissory note is held by the lender until the debt has been paid in full. Afterward, it is returned to the issuer and destroyed.
Promissory Note Example
Williams asks his friend Davis to give him a loan of $1000. He promises to pay back the loan with 10% interest after 20 days. Davis asks Williams to put his promise into writing and sign it. Williams does so, and Davis gives him the loan. After 20 days, if Williams doesn’t pay Davis back the loan amount plus the interest, Davis can sue him.« Back to Glossary Index