An Unsecured Promissory Note is a contract that allows a lender to record the details of the amount of money given to a borrower with the intention of being reimbursed with interest if any.
This type of promissory note is a non-collateral document which means that the loan is not backed by property or assets if the borrower cannot make the required payments. Lenders assume the risk that the amount lent may not be repaid should the borrower default. It is, therefore, important that a lender considers the credibility of a borrower before signing an unsecured promissory note.
A lender that uses an unsecured promissory note can only seek recourse through the debt collector process to demand repayment. This process includes offering the borrower a debt settlement agreement, sending the borrower a letter demanding payment of the loan, or in extreme cases, filing a lawsuit against a borrower in a small claims court.
The agreement made between a borrower and lender will determine the payment structure used in a promissory note. Typically, borrowers and lenders agree for payments to be made in either monthly or weekly installments at certain dates and without penalties for prepayments. A promissory note issued by an individual is known as a banknote. An unsecured promissory note usually accompanies a loan in order to ensure that an agreement detailing how repayments will be made by the borrower is established.
Secured Promissory Note vs. Unsecured Promissory Note
Promissory notes can either be secured or unsecured. Distinguishing the major difference between a secured and an unsecured promissory note is crucial when deciding to lend or borrow money from a party or entity. Using a secured promissory note means that the loan is backed by assets that the borrower has put up as collateral. Therefore, if the borrower defaults on payment of the loan, he/she forfeits the collateral to the lender. Borrowers can put up deeds of trust, personal property such as cars, jewelry, or real estate as collateral. A secured promissory note adds an incentive that encourages the lender to loan money to a borrower. It gives the additional assurance that a borrower will pay back the loan.
On the other hand, an unsecured promissory note relies heavily on the borrower’s word as he/she is not required to put up collateral for the loan. This means that the lender must trust the borrower to repay the loan as agreed. An unsecured promissory note is popular among individuals that are well known to each other such as family and friends, due to the risks associated with it. Therefore, the main difference between using a secured promissory note and an unsecured promissory note is the presence of collateral.
Can Promissory Note Hold up in the Court?
Promissory notes are legally binding agreements, so they will hold up in court whether they are secured or unsecured. An unsecured promissory note may present challenges when a lender is demanding payment of the loan from the borrower; however, it may be considered an established notice for a lawsuit. Therefore, a lender considering litigation over persistent payment default should seek the help of a licensed legal attorney before taking any action. The attorney will advise the lender on what appropriate legal actions should be taken based on the terms of the promissory note.
How Enforceable is an Unsecured Promissory Note?
Using an unsecured promissory note places the lender at risk should the borrower default in paying back the loan or go bankrupt. This, therefore, makes it a necessity for a lender to use various means to collect payment from the borrower.
The following are actions the lender can take to enforce payment:
Speak to the borrower in person
The lender can meet with the borrower to discuss why payment of the debt has not been made as agreed, leading to dialogue between the two parties on how to deal with the situation. It can also provide the lender with an opportunity to inform the borrower that he/she will be seeking the services of a debt collector or arbitrator if the debt is not paid.
Draft a demand notice/letter
The lender can demand payment of the loan in writing. This will help ensure that the lender can prove that the borrower was warned before legal action was taken. The lender must ensure the demand note contains the name of the borrower, the date when the promissory note was signed, the amount owed, and the installment amounts/payment date.
Send a follow-up letter
If the borrower does not respond to the demand note, the lender can send a follow-up note to restate steps that will be taken if the borrower fails to pay back the loan as agreed. The lender should ensure that the follow-up letter contains the date and nature of the previous note/letter sent to the borrower, restatements of the details indicated in the demand letter, and restatement of the consequences the borrower will face if he/she fails to make the payments.
Enlisting the assistance of a professional collection agency
The lender can also enlist the help of a professional and credible collection agency to pressure the borrower to pay the debt. The lender must ensure that the collection agency he/she chooses is known for its ethical debt collection practices.
Filing a claim or petition in court
If all the other enforcement methods fail, the lender should sue the borrower for default in payments. The petition should be filed depending on the owed amount and the circumstances of the debt. The lender should enlist the help of an attorney when taking legal action.
What is an Unsecured Promissory Note Template?
An unsecured promissory note template is a document that outlines the details of the agreement made between the lender and the borrower on the reimbursement of the amount lent, repayment arrangements, and interest(if any). In addition, it helps provide evidence of the debt owed to the lender when or if legal action is taken. An unsecured promissory note template can be tailored to meet the requirements of the lender and the borrower.
Essential Elements of the Unsecured Promissory Note Template
The unsecured promissory note template should contain certain basic elements to guarantee reliability. Including the essential elements of the unsecured promissory note, the template will help ease collection endeavors by lenders.
An unsecured promissory note template should contain the following elements:
Date and details of both parties
The identities of the lender and borrower should be indicated in the unsecured promissory note template. Both parties must provide their names, addresses, and contact information. The lender can be an individual or an entity. The date should also be provided to ensure a proper record is kept of when the document was signed.
A promise from the borrower
The borrower must write a statement expressing his/her willingness to repay the debt owed to the lender. The borrower must also state his/her intention to repay the loan and adhere to the terms of the unsecured promissory note template. This will be proof of the commitment made by the borrower to repay the loan.
The loaned amount and the interest rate
The amount loaned to the borrower should also be indicated in the unsecured promissory note template. A specific amount should be provided to ensure clarity as to how much money will be lent to the borrower. The unsecured promissory note template should also include the interest rate levied on the lent amount if any. The date the interest will be expected should also be stated.
An unsecured promissory note template should contain information on the type of repayment that the borrower and lender have agreed on. Repayment types are different methods of repaying the loan.
For example, the following are repayment types that may be indicated in the unsecured promissory note template:
- Installments: Installment is a type of repayment made regularly throughout a fixed period. Typically, lenders and borrowers will agree to monthly installments if the loan is long-term. The principal amount and interest paid on each fixed period are calculated to ensure the loan is fully paid by the due date.
- An Interest-only payment: An Interest-only payment requires the borrower only to pay the interest placed on the loan. Borrowers that make interest-only payments are not restricted from making extra payments during certain payment periods to help lower the regular interest payments. It can be useful for borrowers with variable income.
- Lump-sum: Lump-sum repayments are when the borrower agrees to cover the full sum in a single payment by the due date specified in the unsecured promissory note template. If the demand promissory note does not specify a maturity date, the lump sum payment is made on the lender’s demand. It is commonly used in short-term loans, and often, a lender will provide the borrower with a few days’ notice before making the demand.
- Balloon payment: A balloon payment is a large one-time payment at the end of the loan term. It combines the lump-sum payments and the installments. A borrower can cover a balloon payment by making periodic payments of the principal amounts and the interest or simply the interest, therefore paying the lump sum at the end of the loan term.
The unsecured promissory note template should break down information on the payment schedule. This will help establish specific facts on how the borrower will undertake the payment.
The following information should be provided when writing the payment schedule:
- The frequency of payments: Frequency of payment refers to how the borrower should make regular payments. Monthly payments are the most common repayment frequencies; however, lenders will provide borrowers with other options such as weekly, bi-weekly, semi-monthly, etc. Therefore, repayment frequencies will depend on the amount owed.
- Payment receivers: Payment receivers refer to the allocation of payment once received by the lender. This will help provide a detailed explanation of how a payment made by the borrower is broken down. The lender can divide part of the payment into interest and the principal amount.
- The amount of the payments: The amount of the payments refers to the amount of money the borrower should pay each scheduled period, such as each month, week, etc. This ensures that the lender can monitor if the borrower is meeting payment requirements as agreed.
The unsecured promissory note should stipulate any additional fees that may be imposed on the borrower. Terms that explain why there are additional fees should be indicated to avoid disagreements over the fee paid. Additional fees may include late payment fees, attorney fees, etc.
Procedures for late payments or defaults
Procedures for the lender’s actions if the borrower makes a late payment or defaults should be indicated. The step-by-step procedure should be well outlined in the unsecured promissory note template. It will help ensure the borrower knows when the lender will consider the loan as a default
Signature of all parties
Both the lender and the borrower must sign the unsecured promissory note template to make it legally binding. In addition, the witness present at the signing should also sign the document. This will ensure that both parties can prove that they consented to the agreement.
Waivers are used when a party wants to relinquish rights and privileges. If the lender agrees to a zero waiver or no waiver policy on notice of default, then this means that if the lender accepts default at one time, the same may not apply at another period/time of default. Therefore, the borrower will have to seek permission afresh and separately.
The unsecured promissory note should contain a notarization seal to help prove the authenticity of the document if or when presented before a court of law. However, state laws will determine if the notarization of the unsecured promissory note is mandatory.
Pros and Cons of Using the Unsecured Promissory Note
Using an unsecured promissory note has advantages and disadvantages for the lender and the borrower. Identifying and understanding them will help both parties make an informed decision on whether to sign an unsecured promissory note template.
Advantages of an unsecured promissory note for a lender
- The lender can charge high-interest rates. This means that the lender will obtain good returns compared to having the money lay in a bank account.
- The lender can sell as well as borrow against the unsecured promissory note. This will help the lender when he/she needs money, making it convenient for a rainy day.
Disadvantages of an unsecured promissory note for a lender
- Unsecured promissory notes are risky compared to other investments. This is because it is not backed by collateral.
- If a borrower defaults in making repayment, the lender can only collect payment after filing a lawsuit.
- It is not easy to sell an unsecured promissory note. Finding a buyer is difficult, and a discount should be offered to incentivize buyers to purchase the promissory note
Advantages of an unsecured promissory note for a borrower
- A borrower can use a promissory note to borrow money in his/her time of need. This is especially useful for businesses without sufficient credit ratings to enable them to obtain money from lending institutions and banks.
- It helps a borrower assure the lender of payment. In addition, this helps encourage the lender to trust in the borrower’s word.
- It helps the borrower avoid pledging any of his/her assets as collateral. This ensures that the borrower does not lose valuable property or assets for a loan from a lender.
Disadvantages of an unsecured promissory note for a lender
- The borrower may pay a higher interest rate compared to what he/she would pay using a secured promissory note.
- The borrower runs the risk of default if he/she lacks repayment funds. In addition, this may lead to the borrower appearing in court if the lender files a lawsuit demanding loan payment.
- When obtaining a business loan, borrowers with bad credit ratings may also be required to pay higher interest rates than those paid in commercial banks and financial institutions.
Following are some free downloadable templates for you:
Frequently Asked Questions
In what ways is a promissory note repaid?
A promissory note can either get repaid in installments, lump sum, or balloon payments. These multiple methods ensure the flexibility of the promissory note; therefore, a borrower and seller can agree on an option that is reasonable and appropriate to their circumstances.