The phrase "promissory note" means just what it sounds like. It's a promise to pay a certain amount at a future date. While a bank doesn’t view a promissory note the same as having cash in hand, there are situations in which a promissory note may be seen as cash if the bank itself issues it, especially in a mortgage situation. But just because a bank sees its own promissory notes as valid, that doesn’t mean a note you have with a friend or business associate will be treated with the same legality.
Banks often accept promissory notes from individuals, one of the most obvious examples being the promissory note that a new homeowner signs when taking out a mortgage.
What Is a Promissory Note?
A promissory note is a legal document that promises one person will pay another, often in a loan situation. Think of it as an I.O.U. on steroids. When done properly, however, promissory notes are legally enforceable, which means if your friend borrows $10,000 from you and signs a legal promissory note, you can take action if you don’t get your money back within the specified time frame. However, while that piece of paper may be great as evidence if you wind up in court, you can’t exactly fill out a deposit slip and put it in your bank account.
What Makes a Promissory Note Legal?
Before you print off an online template and hand it over to your friend to sign, you need to make sure it’s actually legal. This means, first and foremost, that it needs to state exactly what you’re lending and how you expect it to be repaid. You should include any interest you’re charging, if applicable, as well as the deadline and conditions of repayment. If you’ll only accept cash, for instance, this needs to be included in the document. The document must be signed by both parties and, for added protection, should be witnessed by an impartial third party or, preferably, a notary public. This will ensure the other party can’t later claim she didn’t sign the document.
Bank Promissory Notes
If you’ve ever taken a mortgage on a house, you likely have seen a promissory note. That is a note between the bank and the borrower that states you will pay the money back, adhering to specified terms. The lender holds on to that promissory note until your mortgage is paid in full. In that situation, the bank actually does consider it to have cash value, since the borrower will be paying on that note, with interest, until the loan is paid off.
Evaluating Corporate Lending
Businesses often use promissory notes to pay creditors temporarily while they wait for cash flow to pick up. They may also go to a lender to ask for a loan with a promissory note in place to ensure they’ll pay it back as soon as they can. This isn’t as easy as simply making a request, though. The note itself will need to be registered with the government in that business’s state, as well as with the Securities and Exchange Commission. A business trying to conduct this type of transaction may face intense scrutiny before the promissory note is approved, but it is a way for good businesses to get the financing they need to make it through a rough financial period.
Stephanie Faris has written about finance for entrepreneurs and marketing firms since 2013. She spent nearly a year as a ghostwriter for a credit card processing service and has ghostwritten about finance for numerous marketing firms and entrepreneurs. Her work has appeared on The Motley Fool, MoneyGeek, Ecommerce Insiders, GoBankingRates, and ThriveBy30.