A promissory note, abbreviated as just note, is a legal document specifying the loan contract in detail. It specifies the details of the amount borrowed, called the principal amount, the schedule for paying the amount back, and the rate of interest to be charged. It may also specify the penalties for making late payments, or the allowed grace period. Though either party can prepare a promissory note, generally it is left to the lender to ensure that all the conditions are mentioned therein. After both parties have signed the documents, they are legally bound by the terms mentioned in the promissory note.
Notes Vs IOUs
An IOU (I Owe You) note is different from a promissory note, as the former can't be treated as a legal paper, despite having the seal of approval of a notary. Though an IOU confirms the presence of a debt, it may not contain the specific details for paying back the loan, which is contrary to the comprehensive promissory note. Companies in the business of commercial lending invariably insist on the borrower to read the detailed terms and conditions of the loan before signing the document. Moreover, the borrower needs to retain the note till payment against the loan is due. This is because the document generally includes significant information about the rate of interest and the entire sum, including the principal that needs to be paid back. Since IOUs do not include the details of the financial transaction, those are not considered legal like promissory notes.
A very usual example of making a promissory note is when somebody purchases a new car. As most buyers would not pay the entire cost of the car on the spot, they take a loan from a lender and the same is secured. Before money changes hand, the lender would suggest the terms of the payment, which are put in black and white, then the paper gets signed by both parties. This document, having a legal binding for both parties involved, is as good as a promissory note. The borrower may go anywhere or do whatever he likes with the borrowed amount, the lender has a proof of having loaned the amount.
Legality Issues
Having and producing an appropriately worded promissory note, duly signed by the borrower, is valid in the court of law for taking legal action, if the borrower defaults on the loan payments. Yet, there are certain exceptions. When the person borrowing money can establish in court that he/she signed the document by getting pressurized by the lender, the court can refuse to accept the note. Unless the borrower has signed a written promissory document at its end, it's not taken as a legal document. It implies that, if someone signs a blank page, it can't be considered as binding. Furthermore, such a document should not include unusual conditions, which can be considered illegal in some other place, like an incredibly high rate of interest, or extra fines not stated in writing.
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