An IOU note is one of the most common agreements used between lenders and borrowers. Whether a person is borrowing money from family, friends, or a financial institution it is always wise to place payment terms in writing.
In order for an IOU note be legally-binding, a contract must be executed between all parties involved. The proper term for this contract is a promissory note. This document records the loan amount, interest rate, amount of each payment, due date of each payment, and a default clause that outlines what action will be taken if borrowers default on the contract.
Promissory notes should always be used when borrowing money from family and friends. While there is no minimum loan amount requirement, an IOU note should be put into place when loans exceed $500. Most office software includes preformatted promissory note templates that can be filled in and printed at home. IOU notes can also be purchased for a nominal fee via online websites.
Promissory notes are always used when borrowing funds from a bank or credit union. Whether obtaining a student loan, business loan, or secured loans for automobiles or real estate, the promissory note records the promise to pay.
Private funding sources are allowed to charge interest against borrowed funds. However, interest rates must be in compliance with state usury laws. Under IRS guidelines, personal loans over $13,000 should be secured with a promissory note and assessed interest to prevent borrowers from being subjected to gift taxes.
An IOU note may or may not have to be witnessed by a third party such as a notary public. Must depends on the type of assets secured by loans, the funding source, and the jurisdiction where the loan originates. That being said, it can never hurt to have promissory notes notarized, especially if there is any concern that borrowers will default on the terms.
A good source for entering into privately funded loans is Virgin Money. This social lending company was founded by Sir Richard Branson and offers a unique lending program. Borrowers can use Virgin Money tools to establish loan documents, create IOU notes, and track payments.
Virgin Money can be a good alternative when borrowing money from family or friends, especially if loans exceed $500. Relatives and friends are often leery of lending money for fear it will never be repaid. Establishing legal contracts and using Virgin Money's payment processor can minimize lending risks and put lenders at ease knowing they have legal recourse if the loan goes bad.
IOU notes can be sold to private investors in exchange for lump sum cash. Although investors do not pay full face value of the note, this strategy can be used when private funding sources require cash or no longer want to be saddled with collecting the debt.
It is best to consult with a tax accountant or legal advisor when lending large sums of money. While not every transaction requires the use of promissory notes, they should be used when lending money for real estate purchases, banking transactions, raising capital funds for business, and between relatives.
If you have never used a promissory note or engaged in private lending practices, we invite you to learn more about the uses of an IOU note in our personal finance article library.