A loan promissory note is a signed written promise from a borrower to pay a specific sum of money to a lender, either on demand or by a fixed date, on terms both sides agree to in advance. It creates a legally enforceable record of the debt and spells out how much is owed, what interest applies, when payments are due, and what happens if the borrower stops paying. People use them for family loans, seller financing, small business lending, and any other situation where a handshake isn’t enough and a full commercial loan agreement is more than the deal needs.
A note that’s drafted carefully rarely ends up in court. A note with missing terms almost always does.
What Every Promissory Note Needs
Start with the full legal names and current addresses of both the lender and the borrower. Skip the nicknames. Then state the principal, the base sum being lent before interest. From there, the note should cover:
- The annual interest rate, which must stay within your state’s usury ceiling.
- The repayment schedule: monthly installments, a single lump sum, or a mix, with every payment date listed.
- The maturity date, meaning the final deadline for paying the balance in full.
- Late fees, as either a flat dollar amount or a percentage. States cap these differently.
- What counts as a default and what the lender can do about it, including whether the note contains an acceleration clause.
If two or more people are borrowing together, say so explicitly, and say whether each is responsible for the full amount rather than only a proportional share. That concept is called joint and several liability, and without the language the lender may be stuck chasing each borrower for only a fraction of the debt.
Prepayment
A prepayment clause states whether the borrower can pay the loan off early and whether there’s a penalty for doing so. Lenders sometimes want a penalty because early payoff costs them interest income they were counting on. If the note says nothing about prepayment, the borrower’s right to pay early depends on state law. Borrowers should push for a clear “no prepayment penalty” provision in writing.
The Main Types of Promissory Notes
The two biggest structural questions are whether the debt is backed by collateral and when payment comes due.
Secured or Unsecured
A secured note ties the debt to a specific asset such as a car, equipment, or real estate. If the borrower defaults, the lender can seize that collateral to recover the money. An unsecured note has no collateral behind it; the lender is relying on the borrower’s promise and ability to pay. If an unsecured borrower defaults, the lender’s only real option is to sue. Because unsecured notes carry more risk, they usually come with higher interest rates.
Demand or Installment
A demand note has no fixed schedule. The lender can call in the full balance whenever they want, sometimes after a short notice period written into the note. That’s maximum flexibility for the lender and constant uncertainty for the borrower. An installment note locks in regular payments over a set period. The borrower knows exactly what’s due each month and when the loan ends. Most private loans between individuals use installment notes because both sides prefer the predictability.
Balloon Notes
A balloon note is a hybrid. The borrower makes smaller periodic payments through most of the term, then owes a large lump sum at the end. Monthly payments stay low, but the borrower has to produce a substantial amount on the final due date. Balloon payments catch people off guard more than almost any other loan feature. If you’re the borrower, have a realistic plan for that final payment before you sign. If you’re the lender, know that an unpayable balloon is the most common reason these deals fall apart.
Negotiability
A note can also be negotiable or non-negotiable. A negotiable note can be transferred to a third party, who then has the right to collect directly from the borrower. To qualify as a negotiable instrument under the Uniform Commercial Code, the note must contain an unconditional promise to pay a fixed amount, be payable on demand or at a definite time, impose no obligations beyond paying the money, and be payable “to the order of” a named person or “to bearer.” If any element is missing, the note is non-negotiable: it can still be assigned, but the new holder takes it subject to any defenses the borrower had against the original lender.
Interest Rates: State Ceilings and Federal Floors
Every state sets a maximum interest rate that private lenders can charge. Exceeding it can void the interest entirely or expose the lender to penalties. Caps vary widely, from as low as 10% in some states to well above 20% depending on the loan type and amount, and the limits for a loan between two individuals are often stricter than those for commercial lending. Check your state’s usury statute before setting a rate.
There’s also a floor to think about, and it’s a federal one. For private loans, especially between family members or friends, charging no interest feels generous but can trigger tax consequences. The IRS publishes Applicable Federal Rates each month that act as minimum benchmarks for private loans. Charge less than the AFR and the IRS may treat the difference as a taxable gift from the lender to the borrower, and as “forgone interest” the lender owes income tax on even though they never received it.1Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates
The January 2026 AFRs are 3.63% for short-term loans of three years or less, 3.81% for mid-term loans of three to nine years, and 4.63% for long-term loans over nine years.2Internal Revenue Service. Rev. Rul. 2026-2 Applicable Federal Rates Setting your rate at or above the applicable AFR avoids the problem entirely. One narrow exception: gift loans of $10,000 or less between individuals are exempt from the imputed-interest rules, as long as the borrower doesn’t use the money to buy income-producing assets like stocks or a rental property.1Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates
Signing, Notarizing, and Storing the Note
A promissory note isn’t enforceable until the borrower signs it. Wet-ink signatures on paper are the most straightforward option, but electronic signatures carry equal legal weight under federal law. The Electronic Signatures in Global and National Commerce Act provides that a contract or signature cannot be denied legal effect solely because it’s electronic.3Office of the Law Revision Counsel. 15 USC 7001 – General Rule of Validity If you use an e-signature platform, pick one that logs identity, timestamp, and IP address so you have an audit trail if the signature is ever challenged.
Notarization isn’t legally required in most cases, but it adds real protection for a small fee. A notary verifies each signer’s identity through government-issued ID and applies an official seal, which makes the document self-authenticating in many courts. That makes it much harder for anyone to later claim they never signed or that someone forged their signature.
The lender should keep the original signed note. The borrower gets an identical copy. Store both somewhere secure. If a dispute arises years down the line, the party holding the original has a significant advantage.
What Happens if the Borrower Defaults
Missed payments set off a chain of consequences that escalates quickly, especially when the note is well drafted.
Acceleration
Most notes include an acceleration clause, which gives the lender the right to demand the entire remaining balance immediately if the borrower defaults. Contrary to what many borrowers assume, few acceleration clauses trigger automatically on a single missed payment. The lender usually has to choose to invoke the clause, and if the borrower catches up before the lender acts, the lender may lose the right to accelerate. Once the lender formally invokes acceleration, though, the borrower no longer has the option to resume the original installment schedule. The full balance becomes due at once.
Lawsuits, Judgments, and Garnishment
If the borrower still doesn’t pay, the lender’s next step is usually a civil lawsuit to obtain a money judgment. Once the court enters judgment, the lender can pursue collection through wage garnishment and property liens. Federal law caps wage garnishment for ordinary debts at 25% of the borrower’s disposable earnings per pay period, or the amount by which disposable earnings exceed 30 times the federal minimum wage, whichever is less.4Office of the Law Revision Counsel. 15 USC 1673 – Restriction on Garnishment The borrower also ends up owing court costs, and if the note includes a prevailing-party attorney fee clause, the lender’s legal fees too.
Repossession of Collateral
When a secured note goes into default, the lender doesn’t necessarily have to go through court first. Under the Uniform Commercial Code, a secured party can repossess collateral after default without judicial process, as long as the repossession doesn’t involve a breach of the peace.5Legal Information Institute. UCC 9-609 – Secured Party’s Right to Take Possession After Default In practice, a lender can hire a repossession company to pick up a vehicle or piece of equipment, but they can’t break into a locked garage or use physical force.
After seizing and selling the collateral, the lender applies the proceeds to the debt. If the sale doesn’t cover the full balance, the borrower still owes the difference, called a deficiency.6Legal Information Institute. UCC 9-615 – Application of Proceeds of Disposition If the sale brings in more than the debt, the lender must return the surplus. Collateral rarely sells for full market value at a repossession sale, so borrowers should expect to owe something even after losing the asset.
How Long the Lender Has to Sue
Lenders don’t have forever. Every state imposes a statute of limitations on written contracts, and once the clock runs out, the right to sue is gone. The window ranges from as few as three years to as many as fifteen depending on the state. The clock generally starts running from the date of the missed payment, or, if the note has been accelerated, from the date the lender demanded the full balance. Lenders who sit on a defaulted note too long can wait themselves out of their only remedy.
Paying It Off or Changing the Terms
When the borrower makes the final payment, the lender should issue a written satisfaction and release confirming the debt is paid in full. That document protects the borrower against any later claim that money is still owed. If the note was secured, the lender must also release any liens recorded against the pledged property. Keep the satisfaction and release with your copy of the original note indefinitely.
If both sides want to change the terms partway through, whether that means extending the maturity date, adjusting the interest rate, or reworking the payment schedule, put it in a written amendment signed by both parties. Verbal changes are difficult to enforce and easy to dispute. Reference the original note by date and amount, and specify exactly which terms are changing. If the change is generous enough to amount to partial forgiveness, remember that cancelled principal is generally taxable income to the borrower7Office of the Law Revision Counsel. 26 USC 61 – Gross Income Defined and may be a reportable gift from the lender once it exceeds the annual gift tax exclusion, which is $19,000 per recipient in 2026.8Internal Revenue Service. Gifts and Inheritances