What is a Promissory Note Loan?

A promissory note loan is any loan where the lender receives a written promise to repay the loan from the borrower. This signed document is the promissory note. The note will include the amount of the loan and the terms of repayment. The simplest form of a promissory note is the I.O.U., and promissory notes are signed for a wide array of loan purposes, including car loans, business loans, and home loans. There is an active secondary market for promissory notes, and it is possible for holders of private promissory notes to sell them.

Significance

The promissory note is the basis of all commercial lending. Any loan received from a bank, whether or not the loan is secured by collateral such as a car or a house, will require the borrower to sign a promissory note. It is this signed note which makes the default provisions of the loan legally enforceable. Even in the case of unsecured debt such as credit cards, the card holder signs a promissory note at the cash register every time he signs the credit card charge slip.

Function

The function of a promissory note is to detail the amount and terms of a loan and to provide signed proof of the receipt of the loan proceeds and the commitment by the borrower to repay the loan. In the case of a bank loan, the promissory note will include a repayment amortization schedule and will outline the total interest and principal payments over the life of the loan.

Types

There are many types of promissory note loans, as many as there are reasons for taking out a loan in the first place. Borrowers use promissory notes to finance home or vehicle purchases, to start or expand businesses, and in their every day life buying goods and services with credit cards.

Misconceptions

Some borrowers believe that a promissory note loan signed with a private individual lender is somehow less enforceable than a promissory note loan signed with a bank. This is absolutely false. There is no difference in the enforceability of a promissory note loan no matter who the lender is. Once the note is signed it is legal and binding, and the failure of a borrower to perform under the terms of the note is grounds for default and foreclosure of the loan.

Expert Insight

There is an active secondary market in private promissory note loans. Often a home seller will extend a private second mortgage to a buyer in order to make the home more affordable. The note signed between the buyer and seller is worth cash in the market known as "discount paper." The seller will have to accept less than the face value of the note, but he will be able to cash out and not have to worry about collecting the loan payments.