A promissory note is a written, signed promise from a borrower (the “maker”) to pay a specific amount of money to a lender (the “payee”) either on a set schedule or whenever the lender asks for it. Promissory notes create a legally enforceable debt and show up in everything from a loan between siblings to a thirty-year mortgage. The rules that govern them come primarily from Article 3 of the Uniform Commercial Code, which every state has adopted in some form.
What a Promissory Note Contains
A promissory note does not need to be long, but it does need certain pieces to hold up. At minimum, a valid note identifies the borrower and lender by their full legal names, states a specific dollar amount (the principal), and contains an unconditional promise to pay that amount.1Cornell Law School. Uniform Commercial Code 3-104 – Negotiable Instrument Most notes also spell out:
- The interest rate, usually as an annual percentage. It can be zero on a family loan, though the IRS may treat a very low rate as if market interest were being charged.
- The repayment schedule: regular installments, or one lump sum at the end.
- The maturity date, meaning the final deadline for paying the balance. If the note states no payment date at all, it is treated as payable on demand, so the lender can call it due at any time.2Cornell Law School. Uniform Commercial Code 3-108 – Payable on Demand or at Definite Time
- Late fees, typically a flat dollar amount or percentage of the missed payment.
- An acceleration clause, which lets the lender declare the entire remaining balance due immediately if the borrower misses a payment or breaks another term.
- Prepayment terms, meaning whether the borrower can pay the note off early and whether there is a fee for doing so. Federal law restricts prepayment penalties on most residential mortgages.
What Makes the Note Legally Binding
Three things turn a signed page into an enforceable debt: signature, consideration, and delivery.
A person is not liable on a promissory note unless they signed it, or an authorized agent signed for them.3Cornell Law School. Uniform Commercial Code 3-401 – Signature The signature can be handwritten, typed, stamped, or electronic, so long as the signer intends it to authenticate the document. Consideration means something of value was exchanged. Usually the lender hands over money and the borrower hands over the promise to repay. Without that exchange, a court can treat the note as an unenforceable gift promise. Delivery means the signed note has to actually reach the lender; until the lender holds it, physically or digitally, the obligation isn’t active.
The UCC does not require witnesses or notarization for a standard promissory note to be enforceable. A note signed by the borrower and delivered to the lender is valid without either. Notarization can still make it easier to prove the signature is genuine if the matter ends up in court, and some states require notarization for certain secured loans.
Common Types of Promissory Notes
Personal and Commercial Notes
Personal notes cover loans between friends, family, or acquaintances. Because the parties know each other, these notes are often unsecured, meaning no car, house, or other asset backs the promise. If the borrower stops paying, the lender has fewer tools to force collection. Commercial notes are used when a business borrows from a bank or private lender for inventory, equipment, or operating costs. Terms tend to be tighter, and the lender often requires business assets as collateral.
Real Estate Notes
When you buy property with a loan, you typically sign both a promissory note (your promise to repay) and a mortgage or deed of trust (which gives the lender a security interest in the property). If you stop paying, the lender can foreclose because the property itself secures the debt. These notes are usually the longest, often running 15 to 30 years.
Demand Notes
A demand note has no fixed maturity date. The lender can request the full balance at any time, and under the UCC a note that simply doesn’t state a payment date is automatically treated as payable on demand.2Cornell Law School. Uniform Commercial Code 3-108 – Payable on Demand or at Definite Time Demand notes show up in some business lines of credit and revolving arrangements. For the borrower, the risk is plain: the full balance can be called with little warning.
Investment Notes
Companies sometimes issue promissory notes to investors, promising repayment of principal plus a fixed return. These can qualify as “securities” under federal law, which brings SEC registration requirements and anti-fraud protections. The U.S. Supreme Court set out the test in Reves v. Ernst & Young, which presumes a note is a security unless it closely resembles categories such as short-term notes secured by a home or small business, consumer notes, or notes secured by a lien on a small business.4Justia. Reves v. Ernst and Young, 494 U.S. 56 (1990) If you are being asked to buy a note as an investment, the securities question matters; if you are signing a personal or commercial loan, it almost never does.
Selling and Transferring the Note
One of the more consequential features of a promissory note is that it can be sold or transferred, much like endorsing a check over to someone else. To qualify as a “negotiable instrument” that transfers cleanly, the note must meet specific UCC requirements: an unconditional promise to pay a fixed amount, payable to a named person’s order or to whoever holds the document (“bearer”), with no obligations beyond paying money.1Cornell Law School. Uniform Commercial Code 3-104 – Negotiable Instrument
The lender transfers the note by endorsing the back. The UCC recognizes three categories of people who can enforce a note: the current holder, someone in possession who has acquired the holder’s rights, and, if the note has been lost or destroyed, a person who can prove the note’s terms and their right to enforce it.5Cornell Law School. Uniform Commercial Code 3-301 – Person Entitled to Enforce Instrument
For the borrower, transfer means the person collecting payments may not be the one who originally lent the money. Your obligation doesn’t change, but who you owe can. A bank that lends you money for a house can sell your note to an investor on the secondary market, which is how lenders free up capital to make more loans.
Why Transfer Can Hurt Your Defenses
A new holder who takes the note in good faith, pays value for it, and has no reason to know about any problems with it earns a special status called “holder in due course.”6Cornell Law School. Uniform Commercial Code 3-302 – Holder in Due Course That status cuts off most defenses the borrower could have raised against the original lender. If you signed a note because the original lender promised to deliver goods and never did, you may not be able to use that broken promise against someone who bought the note later without knowing about the dispute.
A handful of defenses survive even against a holder in due course. These include fraud that tricked the borrower into signing without understanding the document, legal incapacity (such as being a minor), duress, illegality that voids the obligation under other law, and discharge in bankruptcy.
What Happens When the Borrower Defaults
When a payment is missed or another term is broken, the lender’s options depend on what the note says and whether the loan is secured.
- Late fees as the note specifies.
- Acceleration, if the note includes that clause: the lender declares the entire remaining balance due immediately, not just the missed installment. This is one of the most powerful tools a lender has.
- A lawsuit for judgment. Because a signed promissory note is strong evidence of the debt, these cases often move quickly. A judgment can be used to garnish wages or place liens on the borrower’s property.
- Foreclosure or repossession, if the note is secured by a house, car, or other collateral. The lender uses the process laid out in the security agreement.
If the original note is lost, stolen, or destroyed, the lender can still enforce it, but has to prove the note’s terms and their right to enforce it, and the court will require some protection for the borrower against the risk of someone else turning up later with the same note.7Cornell Law School. Uniform Commercial Code 3-309 – Enforcement of Lost, Destroyed, or Stolen Instrument
How Long the Lender Has to Sue
Lenders can’t sit on a note forever. Under the UCC’s default rule, a lender has six years from the due date stated in the note to file suit. If the lender accelerated the balance after a default, the six years run from the accelerated due date.8Cornell Law School. Uniform Commercial Code 3-118 – Statute of Limitations
Demand notes work differently. If the lender actually demands payment, the six years run from the demand. If the lender never demands and no principal or interest has been paid for a continuous ten years, the note becomes unenforceable.8Cornell Law School. Uniform Commercial Code 3-118 – Statute of Limitations States can set their own periods; across the country, limits for written debt obligations run roughly three to ten years.
How the Obligation Ends
The straightforward way a note ends is full payment. Once the borrower pays the entire principal and any remaining interest, the obligation is discharged.9Cornell Law School. Uniform Commercial Code 3-601 – Discharge and Effect of Discharge Other ways include the lender agreeing to cancel the debt, a bankruptcy discharge, or an accord and satisfaction, where the borrower sends a partial payment along with a clear written statement that it is offered as full settlement and the lender cashes it.10Cornell Law School. Uniform Commercial Code 3-311 – Accord and Satisfaction by Use of Instrument
One wrinkle matters: if the note has been transferred to a holder in due course who had no notice of the discharge, the borrower may still owe that new holder.9Cornell Law School. Uniform Commercial Code 3-601 – Discharge and Effect of Discharge Always get written confirmation when a note is paid off or forgiven, and ask for the original note back marked “paid.”
Interest Rate Limits and Tax Traps
Usury Caps
Every state sets a maximum interest rate for private loans, called a usury cap. The limits vary widely, roughly 5% to 45% depending on the state, the type of loan, and the amount. Many states tie their caps to a benchmark such as the Federal Reserve discount rate, so the limit moves over time.
Charging above the legal rate can be costly. At the federal level, a national bank that knowingly charges more than permitted forfeits all interest on the loan, not just the excess. A borrower who already paid the illegal interest can sue to recover twice the amount paid, as long as suit is filed within two years of the illegal charge.11Office of the Law Revision Counsel. 12 U.S. Code 86 – Usurious Interest – Penalty for Taking – Limitations State penalties range from voiding the note to misdemeanor charges to forfeiture of principal in addition to interest.
Interest Income and Below-Market Loans
Interest you receive on a note is taxable income. Reporting obligations kick in when interest paid to a single borrower reaches $10 or more in a year, though interest on a note issued by an individual (rather than a business) is generally excluded from Form 1099-INT reporting; the lender still owes tax on it.12Internal Revenue Service. Instructions for Forms 1099-INT and 1099-OID
Family loans deserve special attention. If you lend money at little or no interest, the IRS may treat the loan as if market-rate interest were charged. Any loan below the Applicable Federal Rate (AFR) is a “below-market loan.”13Office of the Law Revision Counsel. 26 U.S. Code 7872 – Treatment of Loans With Below-Market Interest Rates The IRS publishes the AFRs monthly. For February 2026, compounded annually, the rates are 3.56% for short-term loans (three years or less), 3.86% for mid-term loans (over three years but not more than nine), and 4.70% for long-term loans (over nine years).14Internal Revenue Service. Revenue Ruling 2026-3 – Applicable Federal Rates for February 2026
When a loan comes in below the AFR, the IRS treats the gap between what the borrower pays and what the AFR would produce as “forgone interest.” For gift loans between family members, the forgone interest is treated as if the lender gave that amount to the borrower, who then paid it back as interest, which can create both income tax and gift tax consequences for the lender.13Office of the Law Revision Counsel. 26 U.S. Code 7872 – Treatment of Loans With Below-Market Interest Rates
Two exceptions soften the rules for smaller loans. If the total of all loans between you and the borrower stays at or below $10,000, the imputed-interest rules don’t apply at all. And for gift loans between individuals that stay at or below $100,000, the imputed interest for any year is capped at the borrower’s net investment income for that year, and if that investment income is $1,000 or less, it is treated as zero.