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Types of Promissary Notes

Promissary notes are legal contracts used in nearly every transaction where money is borrowed. It is a written promise by a borrower to pay a specific amount of money over a set period of time. Oftentimes an interest rate is charged on the borrowed funds, but this is not always the case.

A typical promissary note includes the terms and conditions of the loan. It documents the amount of the loan, what the loan is for, interest rate, late payment fees, frequency and amount of installments, and provisions if the borrower defaults on the loan.

Many promissary notes include a provision known as acceleration. This clause states that borrowers must pay the note in full, along with collection and legal fees if they default on the loan. Caution should be used when entering into promissory agreements that include a default clause as it can have far-reaching consequences.

One of the most important aspects of the promissary note is the repayment schedule. This portion of the document should clearly state the amount of each payment, the due date, and to whom it is payable. Promissory notes should also state whether the borrower is allowed to prepay the loan. Some lenders do not allow prepayment, while others impose a fee for paying the note early.

Different types of promissary notes are used for different types of loans. A simple promissorynote is used when repayment is made in a lump sum. Let's say you need $500 for car repairs and borrow the money from your Aunt Sally. You draft a promissory note, which promises to repay the $500 along with 10 percent interest within 90 days. You then repay Aunt Sally $550 at the end of the note.

Now, let's say you need $5000 for car repairs. In this case, it would be more appropriate to draft an installment promissary note. With this type of note payable, you would pay Aunt Sally monthly installments. A certain percentage of each payment would be applied to the principal and the remainder applied toward the interest.

Depending on your relationship with Aunt Sally, she may or may not require collateral for the loan. If she does, the promissory note would also include details of the personal property used to secure the loan.

Other promissary notes include "Line of Credit" and "Demand" notes. When a borrower establishes a line of credit with a lender, the amount is set forth in a promissory note. The borrower can borrow all or part of the funds, up to the specified amount. Once a portion of the amount previously borrowed or advanced has been repaid, the borrower can make additional withdrawals against the line of credit.

Demand promissary notes are somewhat risky for the borrower because the lender can request payment without advance notice. The borrower pays interest monthly while principal is due on demand. This type of promissory note is usually used by banks and other lending institutions.

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Published on September 07, 2007 at 10:33 AM

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