Michael is a financial planner and has a master's degree in financial services.
This lesson will provide an overview of a promissory note in lending. You'll learn the definition of the term and look at a common example of a promissory note.
Promissory Note: Defined
Sandy is about to enter her freshman year at State University. Unfortunately for Sandy, her parents have refused to provide any financial help after Sandy graduates from high school. With very little savings, Sandy is contemplating applying for financial aid via student loans.
Sandy meets with the financial aid officer at State University. The aid officer tells Sandy she needs to apply for $10,000 of student loans. Sandy is distressed upon hearing this but knows that a college education is for her. The only way for her to begin college is to apply for student loans, which Sandy does promptly.
During the application process, Sandy keeps seeing that the student loan lender is going to require her to sign a promissory note before they release the $10,000 to State University. Sandy is unsure of the meaning of this but does not want to call the 1-800 number listed just to ask a simple question. She decides to continue the application process and finally reaches the end.
'Please sign the promissory note,' reads the header. Sandy opens the promissory note, and after reading the note, she thinks to herself, 'This makes sense! I wish they had told me it would be this simple.'
Sandy's promissory note stated that upon graduation, she promised to pay the lender a certain amount of money by a certain date. Simply put, a promissory note is a written promise by one party to pay another party a certain dollar amount on a certain date.
In Sandy's case, she's agreeing that upon graduation (which is stated as 06/10/2018), she will pay $188.71 to the student loan lender each month, by the first of each month, for 60 months, at a 5% interest rate per year.
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As you can see, some of the items contained in the promissory note include: the borrower (Sandy), the lender (or the student loan lender), the amount borrowed (which is $10,000), the interest rate (5% per year), and the first payment due date (07/01/2018, less than one month after graduation). The promissory note also contains the date Sandy signs the promissory note and may contain the place of issuance (typically a location, such as a city and state).
A promissory note is a little more detailed than an IOU, as it typically contains the repayment terms. However, it's less detailed than a loan contract, as a loan contract typically contains grounds for recourse by the borrower (think of a home mortgage lender that can foreclose on a home if repayment is not made as agreed).
Simply put, a promissory note is a written promise by one party to pay another party a certain dollar amount on a certain date. In our example, Sandy's promissory note contained the name of the borrower, the name of the lender, the amount borrowed, the interest rate, the date the note was signed, and the first payment due date. Sandy learned that promissory notes typically contain repayment terms, whereas IOUs do not. Further, Sandy found out that promissory notes are typically less detailed than a loan contract. Although Sandy wasn't sure at first what a promissory note was, she now understands when, and in what terms, repayment is expected of her.
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