A loan note is a written promise by a borrower to repay a specific sum of money to a lender, either on demand or by a set date, and it spells out the amount owed, the interest that accrues, the payment schedule, and what happens if the borrower falls behind. Most loan notes used in U.S. commerce also qualify as negotiable instruments under Article 3 of the Uniform Commercial Code, which means the lender can sell or transfer the note to someone else and the new holder can enforce it directly against the borrower.1Cornell Law School. UCC Law 3-104 – Negotiable Instrument That combination of features, a self-contained record of the debt plus the ability to change hands, is what separates a loan note from a casual IOU.
What a Loan Note Must Contain
A loan note only works as an enforceable agreement if it nails down a specific set of terms. Missing or ambiguous terms are what borrowers point to when they want to avoid paying, so the details carry real weight.
Principal and Interest
The principal is the exact dollar amount the lender hands over. Every other calculation flows from that number. Interest is the price of borrowing the principal, and it can be set as a fixed rate that stays constant or a variable rate that adjusts on a schedule. Variable-rate notes in the U.S. are commonly tied to the Secured Overnight Financing Rate, or SOFR, which replaced LIBOR as the benchmark for U.S. dollar lending.2Federal Reserve Bank of New York. How SOFR Works The note should also say whether interest is simple or compound, because that changes what the borrower actually pays.
Maturity Date and Payment Schedule
The maturity date is the deadline by which the whole balance must be repaid. A note payable at a definite time gives both sides a clear endpoint. If no maturity date appears, the note defaults to being payable on demand, meaning the lender can call in the full balance at any time.1Cornell Law School. UCC Law 3-104 – Negotiable Instrument
The payment schedule specifies how the borrower repays: monthly installments, quarterly payments, a single lump sum at maturity, or some combination. A common commercial structure is a series of smaller periodic payments followed by a large balloon payment at the end. For consumer loans, federal law requires the lender to disclose the number, amount, and timing of every scheduled payment before the borrower signs.3eCFR. 12 CFR 1026.18 – Content of Disclosures
Acceleration and Default
An acceleration clause lets the lender demand the entire outstanding balance right away when the borrower defaults. Without it, the lender is stuck chasing each missed payment on its own. The note should spell out what counts as default: a missed payment, lapsed insurance on collateral, breach of a financial covenant, or any other event the parties negotiate.
Acceleration typically isn’t automatic in practice. The lender usually has to send written notice identifying the default and giving the borrower a cure window, often 30 days, before the full balance becomes due. Courts often enforce that notice-and-cure structure even when the note reads as though acceleration could be instant. Late fees are another standard feature, typically kicking in after a payment is 10 to 15 days overdue, though state law caps how aggressive those fees can be. Some notes also apply a higher default interest rate to the outstanding balance once a default occurs.
Governing Law
A governing law clause picks the state whose laws will interpret the note and control any dispute. Parties in different states can negotiate which jurisdiction applies. Skipping this clause hands the question to conflict-of-law rules that can produce unpredictable results, particularly around interest rate limits and enforcement procedures.
What Makes a Loan Note a Negotiable Instrument
Not every written promise to pay qualifies as a negotiable instrument. Under UCC Article 3, a note earns that status only when it contains an unconditional promise to pay a fixed amount of money and is payable either on demand or at a definite time.1Cornell Law School. UCC Law 3-104 – Negotiable Instrument If the promise is conditional (say, “I’ll pay $50,000 if my business turns a profit”), it fails the test.
The classification matters because it controls how easily the note can change hands and what protections the new holder receives. A negotiable note transfers through a simple endorsement, similar to signing over a check, and a qualifying new holder picks up powerful legal defenses against the borrower. A non-negotiable note can still be transferred, but the process is slower and the buyer inherits more legal risk.
Common Types of Loan Notes
Secured Notes
A secured loan note names specific collateral, such as real estate, equipment, or financial accounts, that the lender can seize if the borrower defaults. The lender’s claim on the collateral has to be properly recorded through a step called perfection, usually by filing a financing statement with the appropriate government office. A lender who skips perfection can lose priority to other creditors, defeating the whole purpose of taking collateral.
Unsecured Notes
An unsecured note rests only on the borrower’s promise and creditworthiness. If the borrower defaults, the lender has to sue, win a money judgment, and then try to collect against the borrower’s general assets. That path is slower, more expensive, and carries a real risk of collecting nothing. Unsecured notes usually carry higher interest rates to reflect the added risk.
Corporate Notes
Businesses use loan notes to raise capital, and these instruments often include detailed covenants beyond what a personal note would carry. Financial covenants can require the borrower to maintain a minimum debt-to-equity ratio or a specified cash balance. Operational covenants can bar selling major assets or taking on new debt without the lender’s consent. Breaking any covenant can trigger default and acceleration, even if payments are current.
Convertible Notes
Startups often issue convertible notes to bridge the gap between initial funding and a larger equity round. The note starts as ordinary debt but includes a term letting the holder convert the outstanding principal and accrued interest into equity shares when the company raises a qualifying financing round. The conversion typically happens at a discount to the price paid by new investors, or subject to a valuation cap that limits how high the conversion price can go. Both mechanisms compensate the early investor for taking risk before the company had a track record.
Demand Notes
A demand note has no fixed maturity date. The full balance becomes due whenever the lender asks for it.1Cornell Law School. UCC Law 3-104 – Negotiable Instrument That gives the lender maximum flexibility and leaves the borrower exposed to a call at any time. Demand notes show up frequently in intercompany lines of credit and family lending arrangements. If you’re borrowing under one, keep enough liquidity around to cover the balance on short notice.
Transferring a Loan Note
One of the most useful features of a loan note is that the lender can sell it. Instead of waiting years to be paid out, the original lender can transfer the note to another investor for cash today. How the transfer works depends on whether the note is negotiable.
Negotiable Notes and Holder in Due Course
A negotiable note transfers through endorsement and delivery. The original payee signs the note over, the new holder takes possession, and the deal is done. A new holder who pays value, acts in good faith, and has no notice of problems with the note becomes a “holder in due course.”
That status is worth a lot. A holder in due course takes the note free of most defenses the borrower could have raised against the original lender, such as a breach of the underlying contract or a failure to deliver promised goods. Only a narrow set of defenses survive: infancy, duress, lack of legal capacity, certain kinds of fraud, and discharge in bankruptcy.4Cornell Law School. UCC 3-305 – Defenses and Claims in Recoupment That protection is what makes negotiable notes attractive on the secondary market.
Non-Negotiable Notes and Assignment
A non-negotiable note transfers through a formal legal assignment. The critical difference is that the new holder inherits every defense the borrower could have raised against the original lender. If the original lender breached the deal, the borrower can raise that defense against whoever bought the note.
For any assignment to redirect the borrower’s payments, the borrower has to get proper notice identifying the new holder and telling them where to send future payments. Until that notice arrives, the borrower can keep paying the original lender and get full credit.5Cornell Law School. UCC 9-406 – Discharge of Account Debtor; Notification of Assignment
When a Loan Note Becomes a Security
A loan note that looks like ordinary debt can cross into securities law territory, triggering registration requirements and antifraud rules most private lenders never see coming. In Reves v. Ernst & Young, the Supreme Court held that every note is presumed to be a security unless it strongly resembles a recognized non-securities category.6Justia Law. Reves v. Ernst and Young
Courts rebut that presumption by weighing four factors: the motivations of the parties (is the seller raising general operating capital and the buyer chasing investment returns?), the plan of distribution (is the note marketed to a broad group?), the reasonable expectations of the public, and whether another regulatory scheme already reduces the risk enough to make securities law protection unnecessary.6Justia Law. Reves v. Ernst and Young A personal loan between friends almost always passes. A note offered to dozens of investors through an online platform usually does not.
Tax Consequences for Borrowers and Lenders
Interest Income Reporting
A lender who receives at least $10 in interest during the year has to report that income to the IRS, and if the borrower paid $10 or more, the lender must also issue a Form 1099-INT to the borrower.7Internal Revenue Service. About Form 1099-INT, Interest Income Private lenders between family members or friends sometimes skip this step, but the IRS expects the income reported no matter how informal the arrangement.
Below-Market Loans and Imputed Interest
Lending at an artificially low rate, or at no interest at all, can trigger the imputed interest rules. The IRS treats a below-market loan as if the lender charged the applicable federal rate (AFR) and then gifted the difference back to the borrower. For a demand note, the benchmark is the federal short-term rate. For a term loan, the applicable rate depends on the note’s duration.8Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans with Below-Market Interest Rates As of April 2026, the short-term AFR is 3.59% and the mid-term rate is 3.82%, compounded annually.9Internal Revenue Service. Rev. Rul. 2026-7 – Applicable Federal Rates
Two exceptions matter for individuals. If the total outstanding balance between two individuals stays at or below $10,000, the imputed interest rules don’t apply, so long as the loan isn’t used to buy income-producing assets. For gift loans up to $100,000, imputed interest is capped at the borrower’s actual net investment income for the year.8Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans with Below-Market Interest Rates
Original Issue Discount
When a note is issued at a price below its face value, the gap between the issue price and the face amount is called original issue discount, or OID. The holder can’t wait until maturity to recognize that discount as income; a portion has to be included in gross income each year over the note’s life, even though no cash is received until the note pays out.10Office of the Law Revision Counsel. 26 USC 1272 – Current Inclusion in Income of Original Issue Discount Loans between individuals totaling $10,000 or less that aren’t made in the lender’s business are exempt.
Consumer, Military, and Usury Limits
Truth in Lending Disclosures
When a business lender extends consumer credit under a loan note, Regulation Z requires specific disclosures before the borrower signs: the annual percentage rate (APR), the finance charge in dollars, the total amount financed, the total of all payments over the life of the loan, and the complete payment schedule.3eCFR. 12 CFR 1026.18 – Content of Disclosures The APR and finance charge have to appear with equal prominence.11eCFR. 12 CFR Part 1026 – Truth in Lending (Regulation Z) These rules apply to creditors, not to one-off private loans between individuals.
Military Borrower Protections
Active-duty service members get protections that override whatever the note says. The Servicemembers Civil Relief Act caps interest at 6% on loans the borrower took out before entering active duty, including auto loans, mortgages, credit cards, and student loans. The borrower has to give the lender written notice and a copy of their military orders to activate the cap. Separately, the Military Lending Act limits interest to 36% on most consumer loans taken out while the borrower is on active duty, though it excludes purchase-money loans secured by the item being bought.12Consumer Financial Protection Bureau. I Am in the Military, Are There Limits on How Much I Can Be Charged for a Loan
State Usury Ceilings
Every state sets a maximum interest rate for private loans, and charging over that ceiling can void the interest obligation entirely or expose the lender to penalties. The caps vary widely, with some states in the single digits and others allowing rates above 20% depending on loan type and lender. The applicable limit often turns on whether the lender is a licensed institution or a private party, whether the loan is personal or business, and the dollar amount involved. Anyone making a private loan should check the ceiling in the state whose law governs the note before setting a rate; consequences for exceeding it can include forfeiture of all interest, treble damages, or in some jurisdictions criminal liability.
Signing, Enforcing, and Time Limits
Execution
A loan note becomes enforceable when the borrower signs and delivers it to the lender. The signature can be handwritten or electronic. Under the federal ESIGN Act, a signature, contract, or record can’t be denied legal effect solely because it’s in electronic form.13Office of the Law Revision Counsel. 15 USC 7001 – General Rule of Validity An electronic signature can be any electronic sound, symbol, or process adopted with the intent to sign. Most states have parallel statutes. Notarization isn’t required for most loan notes, though lenders sometimes ask for it to head off later disputes over authenticity.
When the Borrower Defaults
What the lender can do after default depends on whether the note is secured or unsecured. For an unsecured note, the lender sues for breach of contract, wins a money judgment, and then collects through wage garnishment, bank levies, or property liens, all subject to state exemption laws. For a secured note, the lender can go after the collateral directly, and for real estate, that means foreclosure, judicial or non-judicial depending on the state and the security instrument. If the collateral sells for less than what’s owed, whether the lender can pursue a deficiency judgment for the shortfall depends on state law; some states bar deficiency judgments after non-judicial foreclosures, others allow them with limits.
Statute of Limitations
A lender can’t wait indefinitely to sue on a defaulted note. Under the UCC default rule, the statute of limitations for enforcing a note payable at a definite time is six years after the due date. If the lender accelerated the note, the six-year clock runs from the acceleration date.14Cornell Law School. UCC 3-118 – Statute of Limitations Some states use shorter or longer periods, so the governing law clause can significantly affect how long the lender has.
A few events can restart or pause that clock. In many states, a partial payment by the borrower after default restarts the limitations period from the date of the most recent payment. A written acknowledgment of the debt can have the same effect. Sit on a defaulted note too long and the right to enforce it can disappear entirely, which is one reason acceleration clauses get exercised promptly in commercial lending.