A promissory note is a contract between a borrower and a lender that includes all the terms and conditions under which the borrower promises to repay the loan. Promissory note is a binding legal document that must be signed by the borrower before loan funds are disbursed by the lender. The promissory note states the terms and conditions of the loan, including repayment schedule, interest rate, deferment policy, and cancellations. The borrower and the lender should keep this document until the loan has been repaid. Promissory note is essentially a contract between the maker and the party that accepts it, and being so, all the regular contracts rules apply.
Promissory note, being a loan agreement, should state the terms on the loan, default, deferment and other important information that will clear the different situations that might arise during the loan period.
Sometimes, different names are used to describe different types or obligations similar to promissory notes. Below are some different types and some terms commonly used with association to promissory note:
Bond – a written promise or obligation, a certificate of debt (usually interest-bearing or discounted) that is issued by a government or corporation in order to raise money; the issuer is required to pay a fixed sum annually until maturity and then a fixed sum to repay the principal.
Municipal Bond – A bond issued by a state or a political subdivision, such as county, city, town or village. The term also designates bonds issued by state agencies and authorities. In general, interest paid on municipal bonds is exempt from federal income taxes and state and local taxes within the state of issue. However, interest may be subject to the alternative minimum tax (AMT).
Debt – this is a definition of an amount owed for funds borrowed. The debt may be owed to an organization’s own reserves, individuals, banks, or other institutions. Generally, the debt is secured by a note, bond, mortgage, or other instrument that states repayment and interest provisions. The note, in turn, may be secured by a lien against property or other assets.
Principal – The amount of money borrowed to buy somthing or the amount of the loan that has not yet been paid back to the lender. This does not include the interest you will pay to borrow that money. The principal balance (sometimes called the outstanding or unpaid principal balance) is the amount owed on the loan at any given time. It is the original loan amount minus the total repayments of principal you have made to date.
Interest – Interest is an amount charged to the borrower for the privilege of using the lender’s money. Interest is usually calculated as a percentage of the principal balance of the loan. The percentage rate may be fixed for the life of the loan, or it may be variable, depending on the terms of the loan.
Amortization – The preparation of a payment plan for a loan which allows for equal payments to be made to the creditor at consistent intervals over the life of the loan (the amortization period). Each payment covers interest accrued over the interval period with the remainder of the payment being applied to reduce the principal owed. If every payment is made on time and in full over the amortization period, the loan will be completely repaid at the end of the amortization period.
Simple interest – A method of calculating interest obligations in which no compounding of interest occurs. Interest charges are the product of the loan principal times the annual rate of interest, times the number of years or proportion of a year the principal has been outstanding.
Default – The failure of the borrower to make an installment payment on a promissory note when due, or failure to meet other terms of the promissory note, to the extent that a reasonable conclusion is that the borrower does not intend to pay.
Deferment – A period during which the repayment of the principal amount of the loan is suspended as a result of the borrower’s meeting one of the requirements established by law and/or contained in the promissory note. During this period, the borrower may or may not have to pay interest on the loan.
You can create your own Promissory Note with our step-by-step form Wizard. Click here to get started.