What is a promissory note?

A promissory note is a written promise to pay someone money. Use this promissory note when you make a personal loan to someone. The note is the borrower's promise, in writing, to pay you back by making payments over a period of time that you agree on, with or without interest.

Putting your agreement in writing helps make sure that both the lender and the borrower understand just how the loan is to be repaid, including the interest rate (if any), timing of payments, and what happens if a payment is late.

What types of loan arrangements does Nolo's Promissory Note offer?

This agreement offers several loan arrangements, including:

1. Installment Payments. Installment payments are a series of loan payments made on a regular basis. There are two ways that you can structure installment payments:

• Installment Payments Without Interest. The borrower can pay off the loan in equal monthly or annual payments over a set time, usually a number of years, and each of the payments is applied completely to the amount borrowed (the "principal.").
• Installment Payments With Interest (Amortized). The borrower can pay off the loan in equal monthly or annual payments over a set time, usually a number of years, and each of your payments is applied partly to interest and partly to principal. Because it is amortized, the amount applied to interest and principal varies with each payment with more interest being paid during the early period of the loan and more principal being paid during the latter portion of the loan.

2. Lump-Sum Payment. If you and the lender prefer to keep things really simple, this loan may fit your needs. Here you agree to pay off the money you borrowed, plus interest, in one single payment. This works best for a short-term loan or possibly a loan from an affluent parent or grandparent to a child where the promise to repay is seen as an expression of the younger person's intent -- not something that the lender would ever really enforce in court if the payment were delayed.

3. Interest-Only Payments (Balloon Payment). You and the lender may agree that you'll make monthly payments of interest only, and then pay off the entire principal in one lump sum at a date some months or years down the line. The advantage of this method is that the periodic payments you make will be lower than if you were to make payments that included both interest and principal. The disadvantage is that since you're borrowing the principal for a longer time, you'll be paying more interest.

If I do choose to charge interest, how can I collect the interest?

Unless otherwise specified in the note, interest is paid at the end of the borrowing interval, not in advance (this is called paying "in arrears"). For example, if you borrow money on January 1 and agree to pay interest each month, your February payment will cover the interest that accrued in January.

State laws generally allow a lender to charge a higher interest rate for business loans than for individual loans -- in fact, some states put no limit on the rate of interest a business may be charged. But many states have usury laws that cap the rate of interest a lender can charge for loans -- often in the range of 10% to 20%. Friends and relatives aren't likely to charge excessive interest rates, so usury laws are rarely a problem. Check the usury law of your state only if the rate the lender wants to charge exceeds 10%.

Choose a fair interest rate. When you're borrowing from a friend or relative, the sensible way to approach interest is to choose a rate that's fair and benefits everyone involved -- slightly lower than the borrower would pay a commercial lender and slightly more than the lender would earn in a safe investment (such as a money market fund).

Can I secure my loan with the borrower(s) assets or collateral of some sort?

If you want the loan to be secured by specific assets of the borrower, the borrower and lender need to sign a separate security agreement.

A security agreement is included with the purchase of this promissory note. The Nolo security agreement is for use only when tangible personal property is pledged as security. Personal property includes all property that's not real estate. The borrower can pledge personal items, such as a car, boat, clothes, or jewelry, as well as business items that the borrower owns, such as a vehicle, machinery, computer, or furniture.

The lender will also want to file a Uniform Commercial Code (UCC) Financing Statement (also known as a UCC-1) with the appropriate state or county office (typically the state secretary of state). When the borrower pays off the loan, the lender must give the borrower an official discharge of the financing statement, which can be filed at the same place where the financing statement was filed.

Do NOT use real estate as security. If you want this loan to be secured by real estate, see a local real estate lawyer. The borrower will have to sign a mortgage or deed of trust. Again, this form is only for pledging tangible personal property.