Glossary and Definitions
Promissory Note (USA)
A Promissory Note, or Note Payable, is a contract between a party who has borrowed money from another party that has lent the money. This document outlines the terms of repayment in writing, and is signed by both parties. In addition to cases of borrowing money (personal or business loans), a Promissory Note may also be useful in cases of large purchases whereby the buyer cannot pay the full purchase price upfront and promises to pay the remainder of the price at a later date.
The Promissory Note always includes the amount of money owed (this is called the Principal), the interest rate on the owed money, and the date by which repayment should occur (Maturity Date). In the case of a "Demand Promissory Note", the Maturity Date is not listed and the debt must be repaid whenever the lender demands. Often, in this case, the borrower has only a few days' notice to repay the debt. A Promissory Note also usually documents any grace periods allowed for payment, and any penalties that will occur should the borrower default on payment.
Although either party may draft the promissory note, it is usually done by the lender to ensure that the clauses of the document offer sufficient protection. In drafting the document, the parties need to be aware of any "usury" laws in their jurisdiction, which set the maximum interest rate one can charge. Civil, and sometimes criminal, consequences may ensue if usury laws are violated. The lender should also consider whether it wishes to have security for the loan. Securing a loan means that, as a type of collateral, the lender receives a lien or mortgage on the borrower's real estate, or alternately receives recognition of the loan on the title to some item like a car or boat. This way, if the borrower ever declares bankruptcy, the lender may use their security interest to recoup money.
A Promissory Note is not the same things as an IOU (or "I owe you") form. A Promissory Note is an active promise of debt repayment, whereas an IOU simply documents that a debt exists. Usually an IOU does not include specific details of how and when repayment will occur. We recommend documenting loans with a Promissory Note as it is much more comprehensive and serves as a better record of the actual agreement made between the two parties.