A promissory note is simply a “note with a promise” i.e. a document that says that one party promises another party a certain amount of money at a certain point in time. It’s like an IOU (I owe you), but more formal and used to collect cash in return for future receivables.
Below we’ve gather some of the best promissory note templates for Microsoft Word to start with.
Difference between IOU and promissory note
An IOU – pronounced and known as “I owe you” is an informal document that says that one person owes another person money. It doesn’t (necessarily) specify when that money will be paid back or which other terms (interest rate etc) apply. It’s also not negiotiable, which means you can’t just transfer it to another party.
A promissory note is a negotiable document and it’s common for a promissory note to change hands after it’s been issued. It’s governed by a contract and contains the terms of repayment.
So with a promissory note you’ll know when certain amounts of the total are repaid and what happens if the debtor fails to make payment.
What is in a promissory note?
A promissory note contains all the things relevant to the debt, which are:
- the amount that’s being owed
- the interest rate
- the maturity date: when the amount needs to be paid back
- date of issuance: when the note was issued
- place of issuance: where the note was issued
- issuer’s signature: the signature of debtor
As you see above, the party that is owed the money is NOT on the note. Since promissory notes can be traded off, the note is owed by whoever holds it. It is returned to the issuer once the debt has been paid back in full.
Examples in practice
Although the term promissory note may be unfamiliar to you, it’s still very likely that you know of some being used in practice.
You may think that mortgages represent the obligation to repay the money that homeowners owe for their home. But in reality they ALSO sign a promissory note. This note then represents the promise to repay the home loan and stipulates the terms of repayment. The terms are usually the interest rate, late fees and the total amount.
This is probably the most common use case for a promissory note in “regular” peoples’ lives.
A student loan is usually the first situation where someone will sign a promissory note. When they lend the money from a private entity, then students will sign a new note for each loan they take out.
When students take federal loans, it could that there’s only one “master” promissory note that stipulates the general terms. All loaned amounts will then fall under that master note that the student signed.
Real instate investing
Another example where you would use promissory notes is in real estate investing. In the below video you’ll see how to use promissory notes in real estate investing.
Promissory notes are used a lot in the corporate world for short-term financing. They are commonly used for access to cash in return for payback via future receivables.
A common scenario would be where a company needs quick access to cash for purchases, while the customers that they deliver(ed) too have not yet paid there invoices. Since a supply chain can take quite a long time to complete, this is not a rare scenario. Goods may still be in transit to the customers or customers may have negotiated longer payment terms (more and more common with large companies). In those cases accounts receivables will be used to cover the note.
Another scenario, which is more high-risk, is where the company has already tried to get corporate loans or issue bonds – and failed. In these cases the risk for the lender is obviously higher and the terms will therefore also need to be more favorable for the lender (higher interest rate). Typically these kinds of notes will be saleable and traded off as medium to high-risk financial instruments.