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Promissory Note: Terms & Calculations

Promissory Note: Terms & Calculations
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  • 0:02 Promissory Note
  • 0:36 Terms
  • 2:11 Calculations
  • 3:57 Selling a Note
  • 4:50 Lesson Summary
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Lesson Transcript
Instructor: Yuanxin (Amy) Yang Alcocer

Amy has a master's degree in secondary education and has taught math at a public charter high school.

Watch this video lesson, and you will learn how some promissory notes, such as mortgages, can be sold and why they are sold. Learn about the terms or conditions that go into such a note and how money is made with these notes.

Promissory Note

Meet Chris. He is your loan officer. The bank where he works is willing to loan you money so you can purchase a building for your growing business. Of course, Chris won't just hand you the $500,000 in cash you need to purchase the building. That would be foolish, for how would Chris know that he would get that borrowed money back from you?

What Chris does is to write up a promissory note for you. This note is a promise of payment. Once you sign this note, you agree to pay back the money along with any additional fees involved by a specific date.

Terms

This promissory note that Chris has you sign is not just a sticky note saying that you will pay back the $500,000 at some time in the future. This note goes into detail. It contains the terms or conditions that you will follow to pay back this large amount. It includes the interest rate that the bank charges you for borrowing money. This is how the bank makes money off of this transaction. It also includes the payment's terms, such as when you are going to make payments and when the final payment will be made and the loan fully paid off.

In exchange for this loan, the bank also will keep the deed of ownership to the building until your loan is paid off. This is also specified in the promissory note. Once your loan is paid off, then the bank will give you the deed of ownership. But until then, the bank owns the building. This provides the bank with security in case you end up not paying them back.

You might see your promissory note written like this:

Amount: $500,000
Date: Today
Interest Rate: 5% annually
Payment Amount: $2,684.11 due the first of each month
Payoff Date: 30 years from today

This promissory note is telling you that you have 30 years to pay off this loan. If you make a payment of $2,684.11 every month for 30 years, you will have paid off your loan at the end of 30 years. This amount includes the annual interest rate of five percent.

Calculations

How did we calculate our monthly payment? We used this formula:

promissory note

The L stands for the loan amount, the r stands for the annual interest rate, the n stands for the total number of payments, and P stands for the monthly payment. What you do is you plug in your values for the annual interest rate, r, the loan amount, L, and the total number of payments, n. If you are making monthly payments, then your n will be in months and your r, your annual interest rate, will need to be divided by 12 to find the monthly interest rate.

For your loan, we have L is $500,000, r is five percent, or 0.05, and n is 360 for the total number of payments in months. Plugging these values in and remembering to divide the r by 12, we get this:

promissory note

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