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What is a Promissory Note?
Prior to downloading the promissory note template, both borrower and lender must understand what the document does – and what it does not do. In simplest terms, a promissory note is a negotiable instrument (as opposed to an IOU, which only acknowledges that a debt was incurred) that outlines an unconditional promise to repay a debt. It represents a legally enforceable contract between businesses and individual persons.
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Understanding the Template
- Amount due: The amount due specifies the amount of the debt that must be repaid.
- Parties: The parties who execute the promissory note are the borrower and the lender. The borrower incurs the obligation of repaying the debt. Please note that the promissory note contains the phrase “for full value received," which further obligates the borrower to acknowledge complete receipt of any goods or services that now place the burden of indebtedness onto that party. If the lender has not yet delivered the good or service, it is not time to sell a promissory note.
- Repayment: The parties may agree to one of two repayment methods. One option institutes monthly payments. The other option stipulates that only payment in full is acceptable. Both options must identify when payment is to be rendered and where. This eliminates confusion over holding on to monies (until both parties may meet up) or mailing them.
- Security: In some cases a lender may ask the borrower to secure the commitment to repay the debt by placing an item in security. For example, a lender may ask to hold on to the borrower’s car title until such time that the loan is repaid. This is an optional clause and one that jeopardizes the borrower’s asset if payment is not rendered. Of course, if the lender does not take ownership of the item at the time the agreement is signed, it is possible that the security clause becomes unenforceable. For example, if the car gets damaged or totaled, it no longer functions as strong collateral.
- Remedies: Adding interest to the unpaid balance is optional on the part of the lender. It is important to keep the percentage below the usury rate, which differs from state to state. For example, Usury Law(1) points out that in California the usury rate for non-consumer loans is an additional five percent on top of the interest rate set for by the Federal Reserve Bank of San Francisco. The State of Ohio considers a personal loan with an interest rate above 21 percent to be usurious. The late payment fee governs penalties that the borrower incurs if the payment is made past the due date. If the borrower defaults, the lender has the option of demanding payment in full, selling the security pledged (and held) or hiring legal counsel to collect the debt.
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The referenced promissory note template is an excellent tool to use when lending money to an entrepreneur, a private person, an employee needing a loan or anyone else. The major pitfalls are a) the lender’s willingness or ability to enforce the note and b) the borrower’s willingness or ability to repay the debt.
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Download: Promissory Note Template
Photo Credit: “1840s Promissory Note" by Second Bank of the United States/Wikimedia Commons at http://commons.wikimedia.org/wiki/File:Promissory_note_-_2nd_Bank_of_US_$1000.jpg