promissory note

A written, dated and signed two-party instrument containing an unconditional promise by the maker to pay a definite sum of money to a payee on demand or at a specified future date.

Investopedia Says:
The only difference between a promissory note and a bill of exchange is that the maker of a note pays the payee personally, rather than ordering a third party to do so.

When a bank is the maker promising to repay money it has received plus interest, the promissory note is called a certificate of deposit (CD).

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Written promise to pay, frequently used in installment loans and commercial loans. A promissory note is the legal evidence of a debt, a promissory note may be transferred to a third party as a Negotiable Instrument. The holder of a promissory note who wants payment before the maturity date can negotiate it by endorsing the note and presenting it to the payer for payment. See also Accommodation Paper; Note; Order.

A promise to pay a specified sum to a specified Person under specified Terms. See also Note.

Quite simply, a promissory note is a promise to pay or an IOU. It is a formal commitment (also known as a loan agreement or contract) between two parties that is usually necessary when money is borrowed and lent between them. All business loans secured from a bank or other lending institution have some sort of promissory note, but they are also recommended for loans between two individuals (even if the loan is between family member or close friends) to avoid any misunderstandings or possible legal troubles.

A promissory note should have several essential elements, including the amount of the loan, the date by which it is to be paid back, the interest rate, and a record of any collateral that is being used to secure the loan. Other interest rate options, like discounting or compensating balance requirements, can also be included. When the promissory note is discounted, the interest is taken off the principal amount at the beginning of the loan. The borrower pays back the entire amount, even though he only received the principal minus the interest. This practice is not very common because it is a higher effective rate of interest than the stated rate for the borrower. A compensating balance is usually required for large loans or lines of credit. It requires that the borrower maintain an account with a specified minimum level account balance at the lending institution (usually a bank). This account balance earns little or no interest and also raises the effective interest rate of the loan. Default terms (what happens if a payment is missed or the loan is note paid off by its due date) should also be spelled out in the promissory note.

When signing a promissory note, both the lender and the person receiving the loan should be fully aware of the note's language. One obvious way to do this is to read the promissory note carefully and in its entirety before committing a signature to it. If there are any questions or confusion regarding the contents of the promissory note, a certified public accountant (CPA) or lawyer should be called on to make sure everything is understandable. When a casual promissory note is drawn up between two individuals, the IRS has a required interest rate. A CPA can help determine if the interest rate stated in the promissory note is too low and if it will result in penalties or automatically be raised. If the loan is interest free, the IRS may consider it a gift and require that a gift tax be paid on it.

Another point that businesses may want to consider when drafting a promissory note is what to do in case the business does not succeed. If the business is a corporation or limited liability company, it should be determined if the corporate shareholders or limited liability members will personally guarantee the loan. If this is not the case, they have no personal legal obligation to repay the loan in a worst case scenario.

Further Reading:

Contracts and Promissory Notes. LawPak, Inc. 1999.

McMillan, Dan. "Notes Causing Headaches." Business Journal-Portland. July 28, 2000.

Nation III, George A. "Promissory Notes in Commercial Lending: Selecting the Best Type of Note for Your Loan." Commercial Lending Review. Fall 1996.

A written promise to pay to another, at a specified time, a stated amount of money or other articles of value.

A signed document containing a written promise to pay a stated sum to a specified person or the bearer at a specified date or on demand.

See the Introduction, Abbreviations and Pronunciation for further details.

A written, signed, unconditional promise to pay a certain amount of money on demand at a specified time. A written promise to pay money that is often used as a means to borrow funds or take out a loan.

The individual who promises to pay is the maker, and the person to whom payment is promised is called the payee or holder. If signed by the maker, a promissory note is a negotiable instrument. It contains an unconditional promise to pay a certain sum to the order of a specifically named person or to bearer — that is, to any individual presenting the note. A promissory note can be either payable on demand or at a specific time.

Certain types of promissory notes, such as corporate bonds or retail installment loans, can be sold at a discount — an amount below their face value. The notes can be subsequently redeemed on the date of maturity for the entire face amount or prior to the due date for an amount less than the face value. The purchaser of a discounted promissory note often receives interest in addition to the appreciated difference in the price when the note is held to maturity.

A promissory note issued by the Second Bank of the United States, December 15, 1840, for the amount of $1,000.

A promissory note, referred to as a note payable in accounting, or commonly as just a "note", is a contract where one party (the maker or issuer) makes an unconditional promise in writing to pay a sum of money to the other (the payee), either at a fixed or determinable future time or on demand of the payee, under specific terms. They differ from IOUs in that they contain a specific promise to pay, rather than simply acknowledging that a debt exists.

Contents 1 Overview 2 See also 3 References 4 External links

Overview

The terms of a note typically include the principal amount, the interest rate if any, the parties, the date, the terms of repayment (which could include interest) and the maturity date. Sometimes, provisions are included concerning the payee's rights in the event of a default, which may include foreclosure of the maker's assets. Demand promissory notes are notes that do not carry a specific maturity date, but are due on demand of the lender. Usually the lender will only give the borrower a few days notice before the payment is due. For loans between individuals, writing and signing a promissory note are often instrumental for tax and record keeping. In the United States, a promissory note that meets certain conditions is a negotiable instrument regulated by article 3 of the Uniform Commercial Code. Negotiable promissory notes are used extensively in combination with mortgages in the financing of real estate transactions. Promissory notes, or commercial papers, are also issued to provide capital to businesses.

Historically, promissory notes have acted as a form of privately issued currency. In many jurisdictions today, bearer negotiable promissory notes are illegal because they can act as an alternative currency.

See also

• Bank note
• Treasury note
• Bond (finance)
• Credit card
• Letter of credit
• Student loan

References

External links

Look up promissory note in Wiktionary, the free dictionary.

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