A promissory note is a signed promise to pay back a loan or debt. Promissory notes are legal documents, similar to a written contract. If constructed properly, a promissory note is legally binding. Promissory notes also are subject to your state's statute of limitations, which specify how long a creditor has to sue the borrower to collect any unpaid amount.
Personal promissory notes are used to record loan agreements between individuals. For example, they often are used to document loans between friends or family members. In some states, they are a requirement when buying a car from a private seller.
Promissory notes also are commonly used for business, commercial and student loans. Real estate transactions also require promissory notes in many cases, generally in combination with a mortgage or deed of trust.
Although attorney often draft promissory notes, anyone can create one. A special form isn't needed to make a promissory note valid, but there are pre-printed forms available at office supply stores or various websites. If you're writing your own promissory note without using a form, it must include certain elements. A promissory note names the borrower and the lender, the amount of the repayment, the terms of repayment, the interest rate and what happens if the borrower defaults.
Promissory notes must be in writing. You can negotiate the terms of repayment, but the promissory note must have a specified end date. The due date can also simply be stated as "when the lender demands." The note must also be unconditional. This means there can't be any exceptions or circumstances that may change the payer's responsibility to pay or terms of the agreement. It must clearly state the exact amount the borrower has to repay. The borrower has to sign the document. Without the borrower's signature, it's not legally binding. The lender can sign the document, but it's not mandatory.
Since promissory notes are legally binding, there are consequences in the event of default. The promissory note state what action can be taken to enforce the note, including filing a lawsuit or placing a lien on the borrower's property. If there's an acceleration clause in the document, it gives the lender the right to demand the entire loan balance plus interest immediately. Defaulting on a promissory note can also have a negative impact the borrower's credit score.
Certain issues can void the promissory note, including missing elements and unreasonable payment terms. States cap the maximum interest rate that can be charged on a loan. The usury limits generally are around 10 percent, but can be as high as 20 percent in some states. If the interest rate agreed to in the promissory note exceeds the state's legal limit, the note is considered void. In addition, charging an illegal interest rate can lead to criminal usury charges.