What is a Promissory Note?
A promissory note is a written, legally enforceable promise by one party (the Maker or Borrower) to pay a specific sum of money to another party (the Payee or Lender) on demand or on a specified date, often with interest. It is a negotiable instrument governed by Article 3 of the Uniform Commercial Code (UCC).
When is a Promissory Note Used?
- Personal loans between friends or family members
- Business loans from private investors or individuals
- Seller financing in real estate transactions
- Student loans and educational financing
- Equipment or vehicle purchases with deferred payment terms
- Business-to-business credit for goods or services
Types of Promissory Notes
Demand Note — Repayable whenever the lender demands payment (no fixed maturity date).
Installment Note — Repaid in regular installments (monthly, quarterly, etc.) over a set period.
Balloon Note — Regular smaller payments followed by one large "balloon" payment at maturity.
Interest-Only Note — Only interest is paid during the term; principal is due in full at maturity.
Zero-Interest Note — No interest charged; only the principal amount is repaid.
Key Terms in the Form
Parties
- Maker (Borrower) — The person or entity who promises to repay
- Payee (Lender) — The person or entity to whom repayment is owed
Loan Terms
- Principal Amount — The original sum of money borrowed
- Interest Rate — Annual percentage rate (APR) charged on the outstanding balance
- Maturity Date — The date by which the full loan must be repaid
- Payment Schedule — Frequency and amount of each payment
- Prepayment — Whether early repayment is allowed, and any associated penalties
Default Provisions
- Events that constitute a default (missed payments, insolvency, etc.)
- Cure period allowed before acceleration
- Acceleration clause — lender's right to demand immediate full repayment upon default
- Late fees and default interest rates
Security
An unsecured promissory note has no collateral attached. A secured promissory note is backed by collateral (real property, vehicle, business assets, etc.) and should be accompanied by a separate security agreement or deed of trust.
Usury Laws
Every state has usury laws that cap the maximum interest rate that can be legally charged. The applicable rate limit depends on the state of the transaction and the type of loan. Charging interest above the legal limit can render the note unenforceable and may subject the lender to penalties.
Always verify your state's usury limit before setting the interest rate.
Enforceability Requirements
A valid promissory note must:
- Be in writing and signed by the Maker
- Contain an unconditional promise to pay a definite sum
- Be payable on demand or at a fixed/determinable future time
- Be payable to order or to bearer
Frequently Asked Questions
Does a promissory note need to be notarized?
Notarization is not required for enforceability in most U.S. states, but it adds authenticity and makes the note harder to challenge. It is recommended for larger amounts.
Can I charge any interest rate I want?
No. State usury laws set maximum interest rate caps. Violating these limits can invalidate the interest provision or the entire note.
What happens if the borrower doesn't pay?
The lender can pursue legal action, which may include filing a lawsuit, obtaining a judgment, and pursuing wage garnishment or property liens (depending on whether the note is secured or unsecured).
Is a promissory note the same as a loan agreement?
A promissory note is simpler and focuses on the promise to repay. A loan agreement is more comprehensive and may include detailed representations, covenants, and other terms. For complex transactions, a full loan agreement is recommended.
Do I need a lawyer to draft a promissory note?
While you can use a template for simple transactions, it's strongly recommended to consult a licensed attorney for larger amounts, complex repayment terms, or cross-state transactions.