There are various financial tools for executing payments. One of the most common is “promissory notes.” In this article we will explain what a promissory note is, its implications and how it works. We’ll also delve into what happens if I don’t pay a promissory note. This matter is a very common reason our experienced NY estate planning attorneys receive questions on a daily basis.
Keep reading. With the information detailed below, you will have the knowledge to make an informed financial decision. This allows you to decide whether to sign a promissory note. And what to look for before doing it. You can also protect yourself from falling into debt that can drag you into a more complex situation, such as bankruptcy.
Specific definition of what a promissory note is
A promissory note is a financial instrument that contains a written promise from one party (the issuer of the promissory note) to pay another party (the beneficiary of the promissory note) a defined sum of money. A promissory note generally contains all the terms related to the borrowing, this includes details such as:
- The principal amount.
- The interest rate.
- The expiration date.
- The date.
- The place of issue.
- The issuer’s signature.
Promissory notes are common documents in any financial service. You have likely signed one if you have obtained any type of loan in the past. Other names that a promissory note may receive are:
- Commercial paper.
- Demand note.
- Loan agreement.
As we mentioned earlier in this article, a promissory note establishes a clear record of a loan, either between individuals or between entities. By putting all relevant details in writing, a promissory note ensures clarity about due dates and the amount of payments. This seeks to avoid any type of misunderstanding or inconvenience between the parties.
When should I use a promissory note?
A promissory note is commonly used for the following transactions:
- Business loans.
- Auto loans.
- Personal loans between friends or family.
- Student loans.
If you are lending money to an individual or business, you may want to formalize the loan by creating a promissory note. A promissory note is especially important if you are borrowing a large amount of money. The promissory note works as a legal record of your loan, helping to protect it and ensure that a person or organization repays you.
Types of promissory notes
Next we will mention the most common types of promissory notes. As you will see, this type of document is used for multiple activities.
Types of promissory notes according to investment use
- Commercial: This type of promissory note is quite formal. Since one of the participating parties is a company that has standardized processes. This part is the one that is normally qualified as a creditor. That is, it lends money to the natural person or company that is committed to paying.
- Personal or informal: This type of promissory note usually involves a family member or friend who lends a sum of money to another family member or friend. Even though the relationship is close, it is always recommended to write down the details of the agreement. So there is clarity of amounts, dates and all commitments. This implies that both parties keep a copy of the signed document. All to avoid misunderstandings and future problems.
- Investment: A company may decide to issue a promissory note to raise capital. This allows you to inject resources into the operation of the company. And thus, to be able to enhance its growth. The company can also sell these notes to other investors. This implies that the company’s proprietary distribution is diversified.
- Real estate: These types of promissory notes accompany a home loan or other real estate purchase. That is, they are part of the payment commitment that is usually contracted in the medium or long term with the creditor.
Types of promissory notes according to type of loan
Different types of promissory notes are appropriate for different types of agreements. When creating or choosing a type of promissory note, you should make sure that it fits the type of transaction in which you are involved. Promissory notes can be as simple as a one-time payment from a friend. Transactions like auto loans and mortgages require more complex promissory notes that cover details like repayment schedules, interest rates, and more.
Types of promissory notes include the following:
- Simple Promissory Note: If you are writing a promissory note for a lump sum payment, you will normally use a simple promissory note. An example is loaning your sibling $ 2,000. Your sibling agrees to pay you back before January 1. A simple promissory note will indicate that the full amount is due on the date indicated; you will not need a payment schedule. You can decide whether to charge interest on the loan amount and include the interest in the document if necessary.
- Pay on demand: A note on demand makes the payment when the lender requests the return of the money. Generally, you will need to provide a reasonable amount of notice to use this type of promissory note.
- Guaranteed note: A guaranteed note secures the amount loaned against a valuable asset, such as a house or vehicle. If the borrower does not repay the loan amount within the agreed term, the lender has the right to confiscate the borrower’s property. For example, when you buy a house, the house is collateral on your mortgage. Your bank can repossess your home if you don’t make the stipulated payments.
- Unsecured Promissory Note: This type of promissory note does not allow the party that lends the money to secure an asset for the loan. If the borrower fails to make the payment, the lender must file it in small claims court or go through other legal processes to enforce the promissory note.
Legal characteristics of a promissory note
Committing to a promissory note is as official as any other debt. The legal implications of this commitment between two parties is regulated by law in the United States. Here are some features to keep in mind if you are considering committing to a promissory note.
The promissory notes are legally binding
A promissory note or letter is a legally binding document. This means that it forces a person or organization to pay another person or organization a certain amount of money in a certain period of time.
Almost all types of loans are considered a legal promissory note of one type or another. However, the question of whether a real note drawn up by people is affected during bankruptcy is often a confusing topic of conversation.
The legal status of personal promissory notes
Following the previous point, personal promissory notes are often viewed by many as mere promissory notes. Personal promissory notes do not receive the same recognition as a credit card agreement or a mortgage note. This is because people believe that they are informal contracts that are simply documented on paper. The reality is that this idea is wrong. In fact, it couldn’t be further from the truth. Let’s continue reviewing this point:
The legal status of a signed promissory note
A signed promissory note or letter of promise, regardless of the amount of money borrowed or the terms of repayment of the money borrowed, is as legally binding and enforceable as a mortgage note on an expensive home. We know that it is easy to get confused. No matter the size of the loan, the obligatory nature of the payment islegally binding.
The promissory notes have the same value as other debts
Do not be confused. The terms and values of a legal note do not matter when it comes to the performance of the note. In the eyes of the law, all promissory notes that are legally signed are considered equal. Therefore, if an individual who has signed a personal note with another individual goes bankrupt, that note becomes part of the individual’s personal liability. This means that the money owed under the promissory note is kept under the terms of the bankruptcy court.
Note: If you want to make sure you have no outstanding debts or promissory notes you can find answers in our article how to know if I have debts in the United States. In it we detail the complete process. We also recommend you review our article where we explain what happens if I am sued and I have no way to pay.
What happens if I don’t pay a promissory note?
The consequences of not paying a promissory note are different for each case. By signing a promissory note, you may be assuming different types of debts. The type of debt acquired by signing the promissory note will determine what happens if you fail to pay a promissory note. That is, what happens if you do not pay the debt on your loan that you promised to pay. Penalties can vary depending on the lenders. And the consequences of not paying the promissory note must be stated in writing at the signature of the promissory note.
As we saw a few paragraphs above, promissory notes are legally binding documents. Someone who fails to repay a loan itemized in a promissory note may lose an asset that secures the loan, such as a home. It could also face other actions.
If you have not paid a promissory note, or if you find yourself trying to get a loan repaid, here are the steps most commonly taken to resolve the matter:
- First, it is usual to request payment in writing. A written reminder may be enough to rush a pending payment. Overdue notices are commonly sent 30, 60, and 90 days after the stated expiration date.
- In the event that after the notifications, the payment status is still pending, the most common next step would be a request for a partial payment. The parties can create a debt settlement agreement. This in case the creditor decides to accept the partial payment of a debt. You can also consider creating an extended payment plan. Thus, this would allow the borrower to repay the full amount over a period of time agreed by both parties.
- There is also the figure of a “debt collector” to obtain payment. A debt collector is an outside person who works to collect the promissory note. Generally the collector takes a percentage of the payment.
- Alternatively, the creditor can sell the note to a debt collector. Selling a promissory note to a debt collector gives the debt collector ownership of the loan and the ability to collect the full amount.
- Usually as a last measure, the creditor can sue the borrower for the full amount owed.
The promissory note should detail the process by which you will repay the loan. You can include the required payment amount and the number of expected payments during a given period. Failure to pay constitutes breach of the agreement.
There are two types of debt: secured and unsecured. In the event of non-compliance with these, the consequences for the debtor will be different.
Breach of Guaranteed Debt
If you have a secured debt, you have signed an agreement that says your lender can take your property if you refuse to pay under the terms of the promissory note. For example, if you bought a car with auto dealer financing. If you do not pay according to the terms of the promissory note, the dealer has the right to repossess the car. In addition, your credit score will also suffer.
If the dealer sells the car for less than the amount you still owe on the vehicle, the dealer could get a deficiency judgment against you. In that case, you still owe money for a vehicle you no longer own.
Breach of Unsecured Debt
If you default on an unsecured debt, the lender cannot take any collateral from you. However, the lender may take different avenues to try to get your payment.
If we take student loans as an example, we will see the following. If you refuse to repay the student loan as agreed in the promissory note, your credit will suffer. If your student loan is held by the federal government, your wages can be garnished and any tax refunds you may have can be withheld.
In the case of non-priority unsecured debts, the creditor may have to sue to recover the debt. If they win the judgment, they could garnish wages and / or bank accounts to obtain the money owed to them.
Note: Constantly stressing about not being able to pay your debts is not a situation that you should take lightly. If you are considering filing for bankruptcy, review here how to file for bankruptcy in New York and our article on consequences of filing for bankruptcy in the United States.
Promissory note debts in bankruptcy
Promissory note debts are official and legally valid debts to be considered as antecedent in a bankruptcy filing process. Below we can see what happens to the most common bankruptcy cases in the United States.
Depending on the type of bankruptcy, the promissory note can be resolved in two ways:
- Through liquidation:
- Through a payment plan.
Chapter 7 removes the liability of the debtor
In Chapter 7 bankruptcy, all personal responsibility for repayment of the promissory note is eliminated and the person no longer has a legal obligation to repay the promissory note. In this case, the individual may agree to repay the promissory note after bankruptcy if the promissory note was between him and a friend, but he is not legally obligated to do so.
Chapter 13 restructures the amortization of the note
In Chapter 13 bankruptcy, the bankruptcy court consolidates all debts. And establish a reorganization plan and monthly payments. In this process, the note holder will receive a refund of the note, but not according to the original terms of the initial legal note.
Note: If you’re interested, here’s our article on Different types of bankruptcies in the United States. And also a direct access to contact with our expert bankruptcy attorneys in New York.
Difference between promissory note and contract
You must be clear that a promissory note is not the same as a contract. A contract spells out all the terms of a legal agreement. A promissory note covers only broadly speaking agreements. That is, the basics to solve a simple loan. A contract is much more detailed. For example, it includes clauses for its dissolution. It also contains antecedents that detail the commercial relationship between the signing parties. Thus, both parties take on a responsibility with which they must comply in a timely manner, as established in the contract.
Some examples of points that are common for both types of documents are:
- The deadline by which someone must be paid.
- How a person or organization should be paid.
- How much should a person or organization be paid.
What should you include if you want to draft a promissory note?
A promissory note must include all the terms and details that both parties to a loan agree to. Important details for any promissory note include the following:
- Payer or borrower: It may seem obvious, but it never hurts to remind you to include the name of the party who promised to pay the declared debt.
- Beneficiary or lender: As in the previous point, include the name of the lender, the person or entity that lends the money.
- Date: Indicate the exact date the refund promise takes effect. And any additional dates that are part of the payment plan.
- Amount or principal: Indicate the nominal amount of the borrowed money.
- Interest rate: In case the loan carries interest, the promissory note must include the interest rate charged. The interest rate can be simple or compound.
- First payment due date: A common agreement is that the first payment is due on the first day of the month and subsequent payments are due on the first date of the following months. However, this can be flexible and agreed on a case-by-case basis by both parties.
- Details of each payment: If multiple payments are due, the promissory note should include the frequency with which the payments will be made, as well as the amount of each payment.
- Promissory Note End Date: In the case of an amortized loan, a loan canceled in a series of even and equal payments on a specified date. The date the promissory note ends could be the last payment. An agreement could also involve a balloon payment, specifying a date when the entire unpaid balance is due.
- Signatures: Make sure the signatures of both the borrower and the lender are included on the promissory note. For a promissory note to be legally enforceable, the document requires the signature of each of the parties.
- Copies of the document: Make sure you have two identical copies of the promissory note. Thus, each party is left with a signed and validated copy for their support.
Note: If you are in a situation of high level of debt, orr if you have already been through the bankruptcy process, you may be interested in how you can fix your credit and you may want to know if you can take out a personal loan after bankruptcy.
Ortiz & Ortiz advises you case by case
Now you know in detail what a promissory note is about. If you have any questions regarding the commitment it means, or regarding what to do in case of non-compliance and its consequences, you already know that you can contact us. Our firm has experts with more than 30 years of combined legal and financial experience serving New York.
We can help and guide you in all aspects of your estate planning. Also in bankruptcy proceedings. And of course in all the legal aspects that these processes imply.
Get in touch with our financial experts. This will ensure that you comply with all applicable rules and regulations governing asset management, promissory notes, and bankruptcy procedures.
Call us today so we can hear about your case and begin to develop an action plan to protect your assets, family, and your financial future.