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Promissory Note: What is it?

A promissory note is a written, legal binding document that obligates one or more persons to pay a person or a business for a loan or collateral. The most common type of promissory note is a loan for a car. If you take out a car loan and you make monthly payments, you signed a promissory note to make those payments. If you don’t make your payment, the financier has the legal right to reclaim the collateral and take you to court to get a judgment for the unpaid amount of the loan.

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Contents of A Promissory Note

Promissory notes can be extremely simple and no more than a paragraph long or it can be extremely detailed and formal in nature. Regardless of the length, promissory notes all contain basic elements.

  • The name of the parties involved. The person or business that is making the loan or providing the property that will be part of a payment plan is referred to usually as the obligator. This means that they are the person to whom money is owed. The person (or persons) who will make the payments is often referred to as the obligee. This means that they are obligated to make the payments.
  • A description of the property or the loan. If someone is agreeing to make payments for personal property of some sort, it would be described. For example, a red 2012 Honda Accord, two-door, and VIN ending in 1234. If there was a loan of money made, the amount would be mentioned. This is important because if either party initiates a lawsuit regarding the agreement, the promissory note is used to give the court the information that they need to make the right decision.
  • The amount of the payment, when it should be made, how it should be made, and interest. It’s important that a promissory note include a description of the payment plan. Those details include the amount of the payment, when the payment should be made (monthly, bi-weekly, or weekly – such as the day of the month or a specific day of the week), and the percentage of interest. If you’re charging interest, make sure that you’re abiding by state laws that may limit the interest that you charge. This section may also include whether there is a grace period.
  • Dated and signed by involved parties.

Both parties should keep a copy of the promissory note for their records. In more complex promissory notes, other provisions include whether the parties must try mediation or arbitration instead of filing a lawsuit. It may also list which jurisdiction would prevail if a lawsuit were filed.