NoteSolutions Answers Your Questions About Promissory Notes
Table Of Contents
- Introduction
- Example Demand Note
- Direct Consolidation Loan Application And Promissory Note
- Typical Bank Mortgage And Note
- Frequently Asked Questions
- Is a promissory note legal in the USA?
- Will a promissory note hold up in court?
- What voids a promissory note?
- Do promissory notes need to be notarized?
- What happens if someone doesn’t pay a promissory note?
- What are the disadvantages of a promissory note?
- What is promissory estoppel?
- Is a promissory note considered a gift?
- Does a promissory note create a lien?
- Is there a time limit on a promissory note?
- Is a promissory note considered income?
- Can you write off interest on a promissory note?
- Can a promissory note be used as earnest money?
- How do you sell a promissory note?
- More Resources For You
Introduction
Words often have two meanings. Especially when a term like “promissory notes” is often referred to simply as “notes.” This can lead to much other usage and confusion. So it’s easy to do an internet search and find results for financial notes and college course notes mixed together. In this article I will provide further clarity on the financial side.
A Promissory Note is a promise to pay an agreed upon amount for an asset or service, according to the terms of a written agreement.
Promissory notes can be secured or unsecured. Secured notes give the note holder a security interest in associated collateral. For example the property being acquired using a lender for financing, would be the collateral used as the security interest.
Promissory notes have wide and varied usage which goes beyond the scope of this article. To narrow our focus here are a few examples:
EXAMPLE DEMAND NOTE
May 9, 2013
$1,000,000.00 (Cdn.)
Toronto, OntarioTo: Craig Creditor
FOR VALUE RECEIVED the undersigned promises to pay to or to the order of Craig Creditor (the "Lender") at 9213 Credit-Ville Road, Toronto, Ontario, Canada:
(a) forthwith after written demand by the Lender for payment, the principal sum of One Million Dollars ($1,000,000.00) in lawful money of Canada; and
(b) interest on such principal sum from the date hereof, and interest on overdue interest, both before and after demand, default and judgment and until actual payment in full, at the rate of 35 per cent per annum, calculated and payable monthly not in advance on the 9th day of each successive month, commencing on June 9th, 2013.
The undersigned hereby waives protest, presentment and notice of dishonour.
The undersigned hereby agrees that all limitation periods established by the Limitations Act, 2002 (Ontario) are hereby excluded and shall not apply to this note, other than the ultimate 15-year limitation period established by such statute. The undersigned also agrees that this note constitutes a "business agreement" as such term is defined by such statute.
Billy Borrower
By:______________
Name:
Title:
This first example is a simple document that instead of specifying an asset or service uses the term “FOR VALUE RECEIVED.” Just looking at it gives you a good visual definition of a promissory note.
Of course there are many ways that promissory notes are used, so the actual documents will vary.
This particular example comes from Canada, so their laws will apply. Also recognize that this is a Demand Note. That means that payment is due whenever demanded, subject to the other terms of the note.
Other promissory notes are written with a lump sum due at a specified date in the future. A very common approach is for the total amount payable to be made in periodic payments over a stated schedule.
The example above comes from a twenty-two page :PDF titled “Promissory Notes” written by David M. Lobl, a Senior Associate at Dentons Canada LLP. Dentons is the world’s largest global law firm.
Mr. Lobl’s paper was written as part of the topic ”BUSINESS LAW FOR TRUST AND ESTATES LAWYERS: EFFECTIVE SUCCESSION PLANNING TO MINIMIZE THE RISK OF LITIGATION.” While this topic may not concern you, keep in mind that promissory notes can become part of an estate. Also notice the simplicity of the actual Example Demand Note used as part of this more complex topic.
Direct Consolidation Loan Application and Promissory Note William D. Ford Federal Direct Loan Program
There is a viewpoint that suggests that promissory notes are mostly used for loans among family and friends. But there are many promissory notes written beyond such uses.
The Direct Consolidation Loan Application and Promissory Note William D. Ford Federal Direct Loan Program is a federal student loan program that utilizes a promissory note. In fact the link above provides the application for this program with the promissory note included as part of the application.
Of course some people will be more interested in this type of note than others. But this example adds to the understanding of promissory notes. It comes in the form of a lengthy PDF that adds much more complexity to the promissory note compared to the first example above. So taking a peek would show more of what is possible.
Typical Bank Mortgage And Note
Probably the type of promissory note familiar to the greatest number of people is a document used in the purchase of a home with borrowed funds. Essentially the same document can be used for bank or private loans and for residential and commercial property, modified as necessary.
The example used here is called a Multistate Fixed Rate Note and at the top of the document simply “Note”.
Common stipulations of a Note are included in this example. They include details of the borrower’s promise to pay, interest rate, time and place of payments, borrower’s right to prepay, and loan charges.
Other sections of the Note include details about the borrower’s failure to pay as required, giving of notices, obligations of persons under this note, and waivers.
The final provision is labeled Uniform Secured Note. So this example applies to a note which is secured by collateral. To tie these matters together, specific reference is made to the “Security Instrument.” Because of the significance I will repeat the first paragraph below:
“This Note is a uniform instrument with limited variations in some jurisdictions. In addition to the protections given to the Note Holder under this Note, a Mortgage, Mortgage Deed, Deed of Trust, or Security Deed (the “Security Instrument”), dated the same date as this Note, protects the Note Holder from possible losses that might result if I do not keep the promises that I make in this Note. That Security Instrument also describes how and under what conditions I may be required to make immediate payment of all amounts I owe under this Note. Some of those conditions are described as follows:”
Depending on the State you live in, the type of security instrument will vary, but the concepts are the same. Here is an example of a Mortgage used in New York.
Just like the Note references the Security Instrument, this Mortgage example references the Note in these words:
“Note” means the promissory note dated ________________, ____, and signed by each Borrower who is legally obligated for the debt under that promissory note, that is in either (i) paper form, using Borrower’s written pen and ink signature, or (ii) electronic form, using Borrower’s adopted Electronic Signature in accordance with the UETA or E-SIGN, as applicable. The Note evidences the legal obligation of each Borrower who signed the Note to pay Lender ______________________________________ Dollars (U.S. $__________________) plus interest. Each Borrower who signed the Note has promised to pay this debt in regular monthly payments and to pay the debt in full by __________________, ________.
So understanding the connection between the Note and Mortgage as quoted above, gives clarity to the main concept that a promissory note is a promise to pay.
This website includes a lot of information about Business Notes and the use of seller financing to sell a business. While the documentation will vary, the same concepts apply as above. There is a promise to pay secured by collateral.
For more about Business Notes, What Is A Business Note? Is a good place to start followed by Make Your Business Note Profitable.
Frequently Asked Questions
Is a promissory note legal in the USA?
Clearly promissory notes are frequently used as legal documents in the USA. Only aspects of a promissory note that are not in compliance with a particular law, would make that part of a promissory note unlawful.
Will a promissory note hold up in court?
If a promissory note is properly constructed to convey what the maker and the holder of the note agreed upon, it should hold up in court. A properly constructed promissory note also requires that it is legally constructed. Consult with an attorney to make sure.
What voids a promissory note?
- Incomplete signatures
- Missing payment amount or schedule
- Missing interest rate
- Lost original copy
- Unclear clauses
- Unreasonable terms
- Past the statute of limitations
- Changes made without a new agreement
Do promissory notes need to be notarized?
No promissory notes do not need to be notarized. But notarizing does verify identities and ensures voluntary signing. This helps to prevent fraud and provides legal protection.
What happens if someone doesn’t pay a promissory note?
That depends on the relationship between the borrower and the lender, and the terms and conditions of the promissory note and any related documents. The relationship could be strictly business or a more lenient approach. Even a strictly business approach has flexibility to restructure the note.
To enforce the note a secured note provides to foreclose on the collateral. An unsecured note would use a lawsuit. A winning lawsuit still would depend on sufficient assets being seized to pay the lawsuit judgement.
Whether secured or unsecured, a defaulted promissory note is called a non-performing note. A non-performing note can be sold using a note broker or note buyer.
What are the disadvantages of a promissory note?
That kind of depends on your alternatives and your point of view. Of course some answers could simply state a high rate of interest, risk of default, complex documentation and lack of regulations. But a note payor will have a different viewpoint than the payee.
In either case, what are you trying to accomplish, and what are your alternatives? The promissory note could become the best resource depending on the circumstances and it allows for a win-win result. You are not forced to sign the promissory note.
What is promissory estoppel?
- “A party makes a promise which he or she should reasonably expect to induce the other party to act or forebear to act in some specific way in reliance on that promise.
- The other party relies on the promise by acting or forbearing to act, and
- Injustice can only be avoided through enforcement of the promise.”
Is A Promissory Note Considered A Gift?
No, a promissory note is not considered a gift. But it could become a gift. A gift is a voluntary transfer of property without compensation.
A voluntary transfer of property without compensation does not meet the concept of a promissory note. So if a gift is intended initially, don’t use a promissory note.
On the other hand the original intent could have been for one party to be paid back by another, so a promissory note could have been used. If the payment or part of it is forgiven, then the amount forgiven, would be considered a gift.
Such a gift could lead to a federal gift tax but often does not. In 2025 the federal gift tax exclusion is $19,000 or $38,000 for spouses. This means that a person could gift up to $19,000 to as many persons as they want without paying a gift tax.
For gifts over $19,000 a lifetime gift tax exemption applies. The current lifetime exclusion is over $13,000,000. If you need more information on this topic consult with the IRS or your tax advisors.
More information is also available at 26 U.S. Code § 7872 - Treatment of loans with below-market interest rates (Legal Information Institute)
Does a promissory note create a lien?
A promissory note by itself does not create a lien, but with proper action a secured promissory note will produce a lien. A lien is a claim by one party against the property held by another. For example, a residential property note is secured by a security agreement such as a mortgage. Recording the mortgage secures a lien against the property. Keep in mind that not all promissory notes are secured, and not all security agreements need to be recorded.
Is there a time limit on a promissory note?
The time limit on a promissory note is known as the statute of limitations. The statute of limitations is based on state law and ranges from three to fifteen years. After the statute of limitations expires, the note holder can still pursue payment of the promissory note, but no longer has the legal right to sue to collect payment.
Some actions may restart or extend the statute of limitations including making a partial payment, acknowledging the debt in writing or signing a new agreement.
Source: UpCounsel Technologies, Inc., How Long Is a Promissory Note Valid? Understanding Time Limits and Enforcement
Is a promissory note considered income?
The person or entity that is the maker of the note is the payor on the note. So for value received, not income, the maker of the note makes one or more payments. The holder of the note is the payee, also known as the lender. For value provided the note holder receives payments.
Payments are typically made up of principal and interest. Receiving principal at fair market value for the asset or service provided is not income. Interst received is taxed as ordinary income. Payments received after one year from the tranaction date are taxed as capital gains if gain is received beyond the original value provided.
Recognize that the use of promissory notes is wide and varied. So a succinct answer can limit proprer understanding. For more input consider What Are The Tax Implications Of Seller Financing?.
Can you write off interest on a promissory note?
This question refers to interest from the perspective of what is paid by the borrower of funds. The answer is subject to the IRS tax code, and the use of a promissory note does not change that. Subject to the tax code, interest on a personal mortgage and used for various business puposes may be written off.
Interest expense may qualify as a credit or a deduction on your federal tax return or it may not be deductible. To get furhter clarification take a look at the
IRS Topic no. 505, Interest expense.Can a promissory note be used as earnest money
Yes a promissory note can be used as earnest money. In order to do so the seller must be willing to accept such a promissory note, and many sellers will refuse. The buyer must be willing to pay on the note as soon as the offer is accepted. A "for sale by owner" deal will be handled differently than by a realtor.The details will vary based on the requirements of the parties involved and regulations they may face.
One concern is that if a promissory note is accepted as earnest money, and the buyer backs out of the deal, the seller will need to file a lawsuit to collect the earnest money payment. In a "for sale by owner" transaction if earnest money is paid by check, and the deal falls through, the buyer could need to file a lawsuit to get their money back.
How do you sell a promissory note?
One option is through NoteSolutions.us. Go to the Quote page, complete the worksheet that applies to your situation, and I will get to work to provide a solution that works for you.
More Resources For You
31 Steps To Success For Promissory Note Owners
Commercial Real Estate Notes Get The Job Done
Are You Prepared To Sell Your Business?
In contact law, a key requirement for an enforceable contract is consideration. That is, one party in a contract makes a promise contingent on the promise of the other party. Money is one form of consideration. Promissory estoppel is an exception to the requirement that consideration is necessary to make a contract enforceable.
Promissory estoppel permits the enforcement of a promise in the absence of consideration where:
For example, a father promises a son $10,000 if he buys a house. Relying on that promise the son buys a house. The promise of the father to pay $10,000 becomes enforceable without consideration because of the son’s reliance on that promise. Under the doctrine of promissory estoppel, the father will not be permitted to avoid his obligation to pay the $10,000.
Source: The Legal Environment Of Insurance, Volume I, American Institute For Property And Liability Underwriters