What is a Promissory Note?

A promissory note, often shortened to 'note', is a legally binding document that states the specific details of a loan transaction and is usually read and signed by people borrowing from most commercial lenders. The note should provide specific details on the amount of the original loan, known as the principal, the loan repayment schedule, and any applicable interest rate; it is not unusual for a promissory note to also contain details regarding any grace periods or penalties for defaulting. Although either party may draw up a promissory note, it's usually in the best interest of the lender to make sure all of the important elements are included. Once both parties sign a note, the precise terms of that contract are the ones that will be enforced during any future legal proceedings.

A promissory note is not the same as an informal "I Owe You" (IOU) because a personal IOU is not always considered a legal document, even if it has a notary seal of approval. While an IOU may acknowledge that a debt exists, the specific repayment details may not be included, as opposed to specific and detailed promissory notes. Commercial lending companies almost always require borrowers to read and sign a very detailed note before a loan can be deposited or processed; the borrower should hold onto this note until the loan becomes due, as it typically contains important information about interest rates and the total amount of principal to be repaid. IOUs are not often viewed as important or valid as notes because they do not usually contain enough details regarding the financial transaction.

A common example of a note being used often occurs when someone buys a new car; many times, a person does not have the thousands of dollars necessary to purchase the car, so a car loan is secured with a lender. Before any exchange of money can take place, the lender will usually request the specific repayment terms to be spelled out in writing and signed by both parties; this document would be considered a promissory note and is legally binding. No matter where the borrower goes or what the borrower does with the money, the lender can prove the existence of the original loan.

The production of a properly worded and signed promissory note is usually enough to prevail in any legal proceeding against the borrower, but there are some exceptions. If the borrower can prove he or she signed the document under extreme duress, meaning under undue pressure from the lender, then a judge may rule the note unenforceable. For a promissory note to be considered legally binding, the borrower must sign a completed document; placing a signature at the bottom of a blank page is not considered binding. Promissory notes should not contain conditions which would be considered illegal elsewhere, such as an impossibly high interest rate or additional penalties not spelled out in writing.