Promissory Notes: How to Lend Money the Right Way

Lending money to a friend or family member without a promissory note is one of the fastest ways to ruin a relationship. Put it in writing. It protects both of you. A promissory note is not about distrust. It is about clarity. When both parties know the exact terms, there is nothing to argue about later.

What Is a Promissory Note?

A promissory note is a written promise to pay a specific amount of money by a specific date. The borrower signs it. The lender keeps it. If the borrower does not pay, the lender has a legally enforceable document to pursue collection. It is that straightforward.

Banks use promissory notes for every loan they issue. Car loans, student loans, mortgages. They all start with a promissory note. There is no reason personal loans should be any different. You can get started with a free promissory note template in just a few minutes.

What to Include in Your Promissory Note

A solid promissory note covers all the details that could become disagreements later. Here is what you need:

• The full legal names of the lender and borrower.
• The principal amount being loaned.
• The interest rate (or a clear statement that no interest is charged).
• The repayment schedule, including payment amounts and due dates.
• The maturity date when the full balance is due.
• Late payment penalties or fees.
• What happens if the borrower defaults.
• Signatures of both parties and the date.

Secured vs Unsecured Promissory Notes

A secured promissory note is backed by collateral. If the borrower does not pay, the lender can take the collateral. Think of a car loan where the bank repossesses your vehicle. An unsecured note has no collateral. If the borrower defaults, the lender has to sue and hope the borrower has assets to collect against.

For personal loans between friends or family, most notes are unsecured. That is fine for smaller amounts. But if you are lending $10,000 or more, consider asking for collateral. It sounds uncomfortable, but it motivates repayment and gives you recourse if things go sideways.

Interest Rates and Usury Laws

You can charge interest on a personal loan, and in many cases you should. The IRS actually requires lenders to charge a minimum interest rate on loans above $10,000. If you do not, the IRS may impute interest and tax you on the income you should have earned. This minimum rate, called the Applicable Federal Rate (AFR), is published monthly by the IRS.

Every state also has usury laws that cap the maximum interest rate you can charge. Go over the limit and your note may be unenforceable, or you could face penalties. Check your state laws before setting a rate.

Promissory Note vs Loan Agreement

People use these terms interchangeably, but they are different documents. A promissory note is a one-sided promise from the borrower to the lender. A free loan agreement form is a two-sided contract with obligations for both parties. Loan agreements are more detailed and typically include representations, warranties, and covenants.

For most personal loans, a promissory note is sufficient. If the loan is complex, involves a business, or includes conditions the lender must meet (like disbursing funds in installments), a loan agreement is the better choice.

What Happens When Someone Does Not Pay

If the borrower stops paying, your promissory note becomes your evidence in court. You can file a lawsuit in small claims court for smaller amounts (limits vary by state, typically $5,000 to $10,000) or in civil court for larger amounts. Having a signed promissory note makes your case dramatically stronger than trying to prove a verbal agreement.

Before going to court, send a formal demand letter. Sometimes a written notice is enough to get payments restarted. If you need to sell personal property as part of the resolution, a free bill of sale template can document that transfer.

The bottom line: never lend money you cannot afford to lose, and always get it in writing. A promissory note takes 15 minutes to prepare and can save you thousands of dollars and years of resentment.