What is a promissory note and what can it be used for?

18 March 2021

Agreeing on a Promissory Note

Promissory notes are legally binding documents between a lender and a borrower of money. They may have terms and conditions similar to any other financial agreements such as loans or contracts, however, promissory notes are likely to have certain details such as:

  • the names of the lender and the borrower
  • the address of the borrower
  • the amount of money loaned
  • the length of the loan period
  • whether or not interest is to be charged and the interest rates that apply
  • what the consequences are if the payments are not made on time, or at all.

a Promissory Note Handshake

What is the difference between a Promissory Note and an IOU?

A Promissory note includes a specific promise to pay, and details of how to repay. An IOU merely notes the existence of a debt, and the amount owed.

A Loan Agreement goes further and will contain more extensive clauses than the promissory note.

When to use a promissory note or IOU

A promissory note can be used when the loan is small, through family or friends for example, or the borrower is unable to find a loan from a traditional lender, such as a bank. However, promissory notes can be much riskier because the lender will normally be a private individual who might not have the money or resources to enforce any non-payment.

How to enforce a promissory note

If you do not take security over the loan and the borrower defaults on the promissory note, you will have to take the borrower to court in order to recover your money and your judgement can be enforced against the borrower’s assets or income. However, if you do take security, then you may be entitled to seize and sell the secured assets if the borrower fails to repay the note.

Are promissory notes legally binding?

Yes, if properly formed and signed then they are a binding contract at law.

Can a promissory note be sold?

Promissory notes that are unconditional i.e. not dependent on some future act by the borrower,  and do not prohibit being assigned (sold or transferred). They can therefore be sold and used almost as a type of currency. Some countries use them frequently in business transactions.

How to make a promissory note

To ensure a promissory note is enforceable you need to make sure it is clear, in writing, contains all the relevant information and is dated and signed. You can make certain that your promissory note delivers all of these elements by using our promissory note template £18* (plus VAT).

John Davies
17th March 2021

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