What is a promissory note and how does it differ from a personal loan?

If you’re struggling to gain approval for a lump sum, whether it’s due to having a poor credit history or outstanding debts, you may be considering turning to loved ones for financial help. 

However, any Australian will tell you that money and friendship/family can be a tricky situation to navigate. So, what protections can you put in place when it comes to borrowing money from family and friends? It may be worth considering writing a promissory note that spells out the terms of the loan between two parties. 

But what exactly is a promissory note, and how does it differ from a traditional personal loan? 

What is a promissory note?

A promissory note can be defined as a document that contains a promise to pay a sum of money, essentially a more formal ‘IOU’. Unlike an IOU it can be held up in court, as once the promissory note is signed, the borrower may be legally obligated to make payment to the payee. 

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.

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.

Difference between a promissory note and a personal loan

A personal loan is a detailed contract between a borrower and a bank or lender that includes 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. If you were to miss repayments on a personal loan or default, this could have significant ramifications for your credit history and credit score. 

A promissory note is generally issued when you lend an amount of money to friends or family members and wish to document the loan - without getting into the complex paperwork that comes with involving a bank. Compared to a loan agreement, it is a simple document used to record a promise to pay back the loaned money. 

You may prefer to use a loan agreement in situations involving more sentimental purchases, where you may not want to involve a financial institution. Such as to assist your children with a house deposit or paying for a wedding.

Do you need to hire a lawyer to write a promissory note?

No, hiring a lawyer to issue a promissory note is not mandatory. 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. 

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.

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.

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