What is a promissory note and when do I need one?

A promissory note can be defined as a document that contains a promise to pay a sum of money, essentially a more formal ‘IOU’. 

One common situation when you may want to use a promissory note is while lending a small sum of money to a friend or family member. Setting up a formal loan agreement may not be suitable in such instances, but a promissory note can serve as evidence of the sum owed to you.

You can find several promissory note templates online or even write one yourself to record a sum of money owed to you or payable by you. If you are lending money, you can use a promissory note to record the loan amount and any interest that may be payable by the other party. 

A promissory note is a simple document that contains a promise to pay an agreed sum of money. Generally, the following details need to be included in a promissory note:

• Names of both parties and their contact details
• Date of issue
• The amount of money borrowed
• Payment terms, including the date by which the loan must be fully repaid, or whether it is payable on demand
• Events of default
• Details of collateral, if any
• Interest details
• Terms for missed or late repayments
• Signature of the borrower. The lender may or may not sign the document, but it will become enforceable once the borrower signs it.

When drafting a promissory note, remember to keep the terms simple. In Australia, promissory notes are governed by the provisions of the Bills of Exchange Act 1909. However, ASIC warns that complex investment arrangements involving promissory notes may be classified as financial products under the Corporations Act, which could lead to additional legal obligations.

A promissory note is generally issued when you lend small amounts of money to friends or family members and wish to document the loan without getting into complex paperwork. Compared to a loan agreement, it is a simple document used to record a promise to pay back the loaned money. On the other hand, a loan agreement is generally a detailed contract that must include information like the purpose of the loan, the obligations of both parties and any late fees or compensation payable to the lender if they face any loss. 

You may prefer to use a loan agreement in situations involving a substantial amount of money, such as when you are lending money to a child to buy a car or put up a house deposit. On the other hand, a promissory note for a small personal loan may suffice to create a paper trail evidencing the loan and payment terms.

No, hiring a lawyer to issue a promissory note is not mandatory. You can write one on your own with the required details and payment terms or use a customisable online template. However, if you wish to include complex payment arrangements, it could be worth seeking help from a legal professional to avoid any confusion or misunderstanding while lending or borrowing money.