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

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

Whether it is to set up a small business or tide through a financial emergency at home or work, people often turn to their loved ones for financial help. But what if your friend Joe refuses to return the $5,000 you lent to him several months ago? Or, what if your uncle lent you some money to set up a business but now claims it to be an investment that gives them a stake in your business? 

To avoid such situations and prevent money issues from turning a relationship sour, it’s generally a good idea to write a promissory note that spells out the terms of the loan between two parties

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’. 

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.

What is the difference between a promissory note and a loan agreement?

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.

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

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.

Questions you may have

Can I repay a $3000 personal loan early?

If you receive a financial windfall (e.g. tax refund, inheritance, bonus), using some of this money to make extra repayments onto your personal loan or medium amount loan could help reduce the total interest you’re charged on your loan, or help clear your debt ahead of schedule.

Check your loan’s terms and conditions before paying extra onto your loan, as some lenders charge fees for making extra repayments, or early exit fees for clearing your debt ahead of the agreed term.

What is a personal loan?

A personal loan sits somewhere between a home loan and a credit card loan. Unlike with a credit card, you need to sign a formal contract to access a personal loan. However, the process is easier and faster than taking out a mortgage.

Loan sizes typically range from several hundred dollars to tens of thousands of dollars, while loan terms usually run from one to five years. Personal loans are generally used to consolidate debts, pay emergency bills or fund one-off expenses like holidays.

Can I merge my personal loan with my home loan?

Yes, you can refinance your home loan and, in the process, merge or consolidate your personal loan and home loan. By doing so, you can lower the number of debts you have, and you may also reduce the total interest you have to pay.

However, you should consult a financial advisor or a mortgage broker to confirm that you are decreasing your total outstanding debt, including interest payments. The repayment term for a home loan can be much longer than that for a personal loan, and by merging the two, you could be repaying a higher amount over the full term.

How long does it take to get a student personal loan?

Completing an online personal loan application can often take anywhere from 10 minutes to 1 hour. Depending on your lender, processing your personal loan application may take anywhere between 1 and 24 hours. If your personal loan application is approved, you may receive the money in your bank account the following business day, or, in some cases, the same day.

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This article was reviewed by Personal Finance Editor Alex Ritchie before it was published as part of RateCity's Fact Check process.

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