A promissory note is a legal contract with a borrower, lender and consideration (money in exchange for a legal promise to repay). Lacking security or collateral, the typical terms involve relatively quick repayment and higher interest rates. Securing a promissory note by offering collateral may provide you with lower interest rates, more money or better terms.
Things You'll Need
- Assets (home, auto, bank account, securities)
- Ability to borrow
- Cash flow for repayment
Decide whether it's to your advantage to secure a promissory note when you are the borrower. A typical personal loan note is a "promise to pay" made by the borrower to the lender. Should that promise not be fulfilled, the lender has remedies under local law but not a right to capture, repossess, or take title to specific property of the borrower. Therefore, you should derive some benefit if you secure a promissory note.
Negotiate with lenders to learn what benefit they will offer if you secure a promissory note. Among the potential benefits a lender may offer you:
-Lower interest rate. By receiving some specific security, the lender may perceive lower risk and offer a lower finance charge in return.
-Increased loan amount. For example, a lender is willing to loan you $5,000 on a personal loan request. You offer additional security (in addition to your promise to repay) in the form of your auto. Your lender may now be willing to increase the amount of the loan.
-Better repayment terms. Your offer to secure a promissory note may result in your lender providing better or longer repayment terms, helping your monthly cash flow.
Prepare (or allow your lender to prepare) a security agreement. Secured promissory loans usually have a "built-in" security agreement as part of the main body of the note. Standard promissory notes typically require a security agreement addendum.
The security agreement specifically identifies the asset pledged as collateral for the debt. For example, if you offer an auto, the security agreement will specify a description of the vehicle and its vehicle identification number, which is unique to each auto manufactured. In this case, you may also be required to give the vehicle title document to your lender, who may record itself as a legal lienholder with your state department of motor vehicles.
Be prepared to offer written evidence of insurance for your collateral if asked by the lender. This may be the only way to protect the lender against casualty loss, theft or other damage to the collateral the lender has accepted. Should you pledge stocks, bonds or other negotiable securities as collateral, you typically must deliver the actual documents to your lender or evidence of their safekeeping by a third party to ensure these assets cannot be sold prior to loan payoff.
Understand your rights and responsibilities after you secure a promissory note. Along with your signed promise to repay, you have secured the loan note by offering one or more of your assets as collateral. You need to maintain the current condition of your collateral and safeguard it against damage or loss. Should you fail to repay as agreed, you risk losing the security you've pledged. If its value is insufficient to satisfy the principal, you could still face legal action should you default.
Tips & Warnings
- Evaluate the benefit of securing a promissory note versus the potential risk of endangering your assets. Should you need to sell a pledged asset, ask the lender if you can substitute another. Be prepared to offer collateral equal to more than the promissory loan proceeds if you are securing the note with marketable securities (as their value can decrease quickly).
- Do not offer to secure a promissory note unless required to by your lender.
- What Is a Promissory Note and Security Agreement?
- How to Use a Promissory Note for Collateral
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