When the maker of a promissory note fails to pay, you generally have three routes: send a formal written demand, negotiate a revised deal, or sue for breach of contract. If the note is secured by collateral, you may also have the right to repossess or foreclose. Which route makes sense depends on the note’s terms, whether an acceleration clause applies, and how much time has passed since the missed payment. Move in the wrong order or miss a deadline and you can weaken your position or lose the right to collect altogether.
Know What Counts as a Default
A default is any failure to do what the note requires. A missed payment is the obvious trigger, but the note itself sets the full list. Late payments arriving after any grace period, failure to keep insurance on collateral, or missing the final lump-sum payment on the maturity date can all qualify, depending on what the parties agreed to.
Before you do anything else, read the note for an acceleration clause. When triggered, it lets you demand the entire remaining balance immediately instead of chasing each future payment as it comes due. If a borrower owes $50,000 spread over five years and misses a single payment, an acceleration clause lets you call the whole $50,000 due now.1Legal Information Institute. Acceleration Clause Without one, you can only sue for the payments already missed, which sharply limits your leverage.
Send a Formal Demand Letter
Start with direct contact. Sometimes a missed payment is an oversight and a phone call or email fixes it. If that goes nowhere, send a formal demand letter by certified mail or another method that proves delivery. This is more than a courtesy. The note itself or applicable law may require written notice before you can accelerate the debt or file suit, and skipping it can cause problems later.
A strong demand letter identifies both parties, references the original note by date and amount, and states exactly what is owed: unpaid principal, accrued interest, and any late fees the note authorizes. If you are invoking acceleration, say so and demand the full accelerated balance. Set a firm deadline. State clearly that you will pursue legal action if that deadline passes. If the note allows recovery of attorney’s fees and court costs, mention that too. Keep the tone businesslike. The letter may end up as evidence, and courts respond better to clarity than to threats.
Try to Negotiate Before Suing
Filing a lawsuit is expensive and slow, and a judgment is only as good as the borrower’s ability to pay it. If the borrower’s trouble is temporary, a modified payment schedule, a short interest-only stretch, or an extended timeline may recover more than a court fight would. If the borrower has some cash but clearly cannot cover the full balance, a discounted lump-sum settlement may put more in your pocket than years of enforcement.
Put whatever you agree to in writing. A verbal deal to accept reduced payments is nearly impossible to enforce if the borrower slips again. A written modification signed by both parties replaces ambiguity with a clear record. This is also the point where paying an attorney to draft a forbearance or modification agreement usually pays for itself.
Sue for Breach of Contract
If the demand letter and negotiation both fail, the next step is a breach of contract lawsuit asking a court to enter a judgment ordering payment.
To win, you need to prove four things: the note exists and the borrower signed it, you actually loaned the money, the borrower failed to pay as required, and you are owed a specific dollar amount. Original documents matter. Keep the signed note, records of the loan disbursement, a payment history showing what was and was not received, and copies of the demand letter with proof of delivery.
Choosing the Right Court
If the amount owed falls within your local small claims limit, that path is worth a look. Small claims limits vary widely by jurisdiction, running roughly from $2,500 to $25,000. The process is faster, cheaper, and designed for people without attorneys. For larger amounts, you will need a court of general jurisdiction, where procedure gets considerably more complex and an attorney becomes important.
What You Can Recover
The core recovery is the unpaid balance: principal plus interest at the note’s stated rate. If the note provides for late fees, attorney’s fees, or collection costs, you can seek those as well. Many jurisdictions also allow prejudgment interest to compensate you for the time between default and judgment. Whether you get it, and the rate, depends on your jurisdiction and the note’s terms.
Secured Notes Give You a Second Path
The single biggest factor shaping your options is whether the note is secured by collateral. A secured note is backed by specific property such as real estate, a vehicle, or equipment. On default, you have the right to seize that property. For real estate, that means foreclosure. For personal property like a car, it means repossession. In many states, a lender can repossess a vehicle without going to court first, as long as it does not breach the peace in the process.2Federal Trade Commission. Vehicle Repossession
Seizing collateral does not always end the story. If you repossess and sell a car for $12,000 but the borrower still owed $20,000, the $8,000 gap is a deficiency. In most states you can pursue a deficiency judgment for that remaining balance, but only if you followed proper procedures. The sale must be conducted in a commercially reasonable manner, and you generally must give the borrower advance notice of it. Cut corners on either requirement and you can lose the right to collect the deficiency entirely.
An unsecured note has no collateral behind it. Your only remedy is a lawsuit, a money judgment, and enforcement against the borrower’s assets. That is why evaluating a borrower’s financial situation before spending money on litigation is a step experienced lenders never skip; if there is nothing to collect from, a judgment may not be worth the paper it is printed on.
Collecting After You Win
Winning gives you a judgment, not cash. You still have to collect, and enforcement is often harder than the lawsuit itself.
The two most common tools are wage garnishment and bank account levies. Federal law caps wage garnishment for ordinary debts at the lesser of 25% of the borrower’s disposable earnings per week or the amount by which weekly disposable earnings exceed 30 times the federal minimum wage.3Office of the Law Revision Counsel. United States Code Title 15 – 1673 Restriction on Garnishment Some states impose tighter limits. A bank levy lets you seize funds in the borrower’s account, though certain amounts may be exempt depending on the source of the funds and local law.
If the borrower owns real property, recording your judgment places a lien on it. The lien attaches to the property and has to be paid when it is sold or refinanced. Slow, but effective when the borrower has equity and you have patience.
Watch the Statute of Limitations
Every note has an expiration date for enforcement, and missing it means losing the right to sue. Under the Uniform Commercial Code, a lawsuit to enforce a note payable on a specific date must be filed within six years of that date. If you accelerated the debt, the six-year clock runs from the accelerated due date. For demand notes where a demand was actually made, you have six years from the demand. If you hold a demand note and never make a demand, the right to sue expires after 10 years of receiving no payments of principal or interest.4Legal Information Institute. UCC 3-118 Statute of Limitations
Those are the UCC defaults, but states modify them. Limitation periods for promissory notes range from as few as three years to as many as fifteen. Check your state’s specific statute before assuming you have six years. Once the deadline passes, the borrower can raise it as a complete defense and the court will dismiss the case regardless of how strong the underlying claim is.
Defenses to Expect
A promissory note is an unconditional promise to pay, which limits valid defenses compared with other contract disputes. Even so, borrowers do raise them. Expect claims that the debt was already paid in full or in part, which is why detailed payment records are essential. Expect claims of fraud or duress, which attack the formation of the agreement itself. Expect a claim that the money was never actually loaned, which is rare when there are bank records or wire confirmations but comes up with handshake-style loans where documentation is thin. Expect a statute of limitations defense if any real time has passed. And expect a claim of material alteration if there is any argument the note was changed after signing without consent, such as an altered interest rate or principal amount.
The best protection is documentation. Keep the original signed note somewhere safe, keep proof the loan was disbursed, log every payment received, and preserve all correspondence. Lenders who treat a note like a handshake tend to find themselves unable to prove their case when it matters.
If the Borrower Files Bankruptcy
A bankruptcy filing changes everything, immediately. The moment the petition is filed, an automatic stay takes effect and prohibits you from continuing any collection activity. You cannot call the borrower demanding payment, proceed with a pending lawsuit, garnish wages, or repossess collateral without first getting permission from the bankruptcy court.5Office of the Law Revision Counsel. United States Code Title 11 – 362 Automatic Stay Violating the stay can result in sanctions.
In a Chapter 7, an unsecured promissory note is generally dischargeable, meaning the borrower’s obligation to pay can be wiped out. Clauses in the note that try to prevent discharge are unenforceable. One important exception: if the borrower obtained the loan through fraud or material misrepresentation, you can file an adversary proceeding arguing the debt should survive discharge. Debts obtained through false pretenses or actual fraud are nondischargeable if you can prove it.
For secured notes, bankruptcy does not automatically eliminate your lien on the collateral. The borrower may discharge their personal obligation to pay the remaining balance, but your security interest in the property generally survives. You can move for relief from the automatic stay to proceed with repossession or foreclosure if the borrower is not making payments on the secured debt during the bankruptcy.
Tax Consequences on Both Sides
When a note goes permanently unpaid, taxes come into play for both parties.
If you loaned money on a note that has become uncollectible, you can claim a bad debt deduction on your federal return. For a personal loan outside a trade or business, the IRS treats this as a nonbusiness bad debt. You must show that the money was intended as a loan and not a gift, that you previously included the amount in income or loaned out your own cash, and that the debt is completely worthless with no reasonable expectation of repayment. A nonbusiness bad debt must be totally worthless to qualify; you cannot deduct a partially uncollectible personal loan. You also need to show reasonable collection efforts, though a lawsuit is not required if a judgment would clearly be uncollectible. The deduction is reported as a short-term capital loss and is subject to capital loss limitations.6Internal Revenue Service. Topic no. 453, Bad Debt Deduction
On the borrower’s side, if you formally cancel or forgive $600 or more of the debt, an applicable financial entity is required to file Form 1099-C with the IRS, reporting the cancelled amount as income to the borrower.7Internal Revenue Service. About Form 1099-C, Cancellation of Debt Even when the form is not required, the borrower may still owe tax on forgiven debt. Worth knowing when you are weighing a discounted settlement, because the borrower’s tax hit can become a negotiation point.
Does the FDCPA Apply to You?
If you are the original lender collecting on your own note, the federal Fair Debt Collection Practices Act generally does not apply. The FDCPA defines a “debt collector” as someone who collects debts owed to another or whose principal business is debt collection. Officers and employees of a creditor collecting in the creditor’s own name are explicitly excluded.8Federal Trade Commission. Fair Debt Collection Practices Act
One trap: if you use a name other than your own during collection that would suggest a third party is collecting the debt, you lose the exemption and become subject to the full range of FDCPA restrictions, including limits on when and how you can contact the borrower.8Federal Trade Commission. Fair Debt Collection Practices Act If you hire a collection agency or an attorney whose principal business is debt collection, that third party is fully subject to the FDCPA even though you as the original lender are not.