It's important to realize promissory notes are legal contracts and can be used against you in a court of law. Before signing any agreement, it's essential to understand the different types of promissory notes and how they are used.

Types of Promissory Notes

The most common types of promissory notes include those used to document personal loans between family members or friends. Most people shy away from requesting legal documentation when lending money to personal acquaintances. While it's understandable you don't want to offend someone you care about, promissory notes can actually help prevent misunderstandings.

When friends and family draft a personal promissory note it demonstrates a good faith effort on behalf of the Borrower. It also creates a sense of security for the Lender. Personal promissory notes can be purchased at office supply stores or downloaded from the Internet. The note should include the terms of the loan, amount borrowed, interest rate and what consequences will occur if the Borrower defaults on the loan.

Commercial promissory notes are used when money is borrowed from a bank or other lending institution. Commercial notes are similar to personal notes; however, they include additional legal terms and more stringent conditions.

Typically, when a Borrower defaults on a commercial promissory note, the lender has the right to demand full payment. If you owe $3,000 and default on your payment, the signed promissory note gives the Lender the power to demand the entire balance. If you do not pay the full balance, the Lender can then place a lien on the property you are financing. They can also file a lawsuit to obtain the balance or regain possession of the property. Not only will you lose the property, it will significantly impact your credit rating.

Some organizations use promissory notes to raise capital for business. This type of business note is referred to as an Investment promissory note. The note is issued to investors in exchange for the loan. Investment notes guarantee investors will receive a return on their investment within a specified period of time.

Negotiable promissory notes are used to secure real estate transactions. These notes are governed by the Uniform Commercial Code. Real estate promissory notes must adhere to conditions set forth by the National Conference of Commissioners on Uniform State Laws.

Personal promissory notes are simple documents and can usually be drafted without the assistance of a lawyer. Commercial, Investment and Real Estate Notes will require the services of lawyer to ensure they are legally binding.

Legal Terms

Should you decide to draft a promissory note without legal counsel, it's wise to become familiar with the terminology used. Basically, there are five legal terms used in promissory notes including:

Promisor - The person who is obtaining the loan and who will be obligated to repay it.

Promisee - The person who is providing the loan and who will receive payment for it.

Obligor - The person who is bound by the legal agreement; usually the Promisor.

Obligee - The person to whom the Obligee is bound; usually the Promisee.

Mutual Consideration - When there is a contract between two parties there must be some value received by both parties. This is referred to as "mutual consideration".