What is a Loan Note?

A loan note, or a promissory note, is a legal document that obligates one party to repay money to another party. A proper loan note also protects the interests of both the lender and the borrower. To do this, the note must describe the loan in enough detail to ensure that no misunderstanding can occur between the parties.

A loan note identifies the date of the agreement and the involved parties, including co-signers, by their full legal names and addresses. The loan amount is specified, including interest and method of calculation. Terms of repayment are spelled out. Payment frequency, due date, conditions under which the borrower will be in default, and consequences of non payment are defined. The form of payment--cash, check or money order, for instance--and the place at which payment is to be made are also noted. Any other conditions of the loan must also be included on the same document.

A loan note may be written in simple language and still be a functional, legal document, but using established legal language for a loan note is safer. For straight-forward lending situations, loan note forms can be purchased at office supply stores or on the Internet. However, when the sum of money is large and the transaction is complex with many conditions--as in real estate loans--a document professionally drafted specifically for the transaction is preferable.

To add veracity to the loan note and provide additional protection for both lender and borrower, the loan note should be signed by at least one impartial witness. The best witness is a notary public. A notary will examine the loan note, witness the signing of the note, and stamp and sign the note. The transaction is also recorded in the notary's record book.

When you sign a loan note, you're stating that you've read the entire document and agree to be legally bound by all conditions cited therein. So whether you are borrower or lender, read the entire document, including all fine print. Make copies of the signed loan note and have them notarized along with the original note. When making or receiving payments, document the payments with a receipt, especially if payment is made in cash.

If property is named in the loan note as security for the loan, this may need to be recorded with a Uniform Commercial Code filing. A UCC filing establishes a public record that the property is collateral against the loan note. Consult an attorney to ensure proper UCC filing, especially in large transactions.

Any detail not included in the loan note will be a matter of "he said/she said" in a court of law, making attempts to collect through legal action difficult or even futile. A common error people make when drafting their own loan notes is omission of the date when the loan must be repaid. Without this information, the loan document is simply an IOU. In theory, the borrower can repay whenever he chooses.