A promissory note is a written document that officially recognizes a legally binding relationship between two parties. Often between a lender and a borrower. True to its name, it serves as a written and enforceable promise to pay an amount of money owed. Both parties understand that money is being borrowed and must be repaid at a future date.
There many different loan arrangements. We highly recommend to first understand the differences. However in general:
- IOU is a much more informal and flexible than a promissory note.
- A note is more informal and flexible than a loan agreement.
- A loan agreement is commonly used for the more complex payment arrangements and often includes a resource for the lender in case the borrower defaults or is unable to pay.
So what Is a Secured Promissory Note?
Many lenders do not provide financing without security. A promissory note is a contract between the bank and the borrower. A secured promissory note is accompanied by other documentation that pledges collateral. The borrower pledges this collateral in the event he can no longer pay and the loan is declared in default.
Unsecured versus Secured
A secured note is accompanied by collateral. In the event the borrower fails to pay back the loan, the lender can legally seize and sell the collateral to recoup its losses. For this reason, lenders prefer notes to be secured. If an unsecured note goes unpaid, the lender can pursue legal action and file a judgment, but if the borrower does not have the means to repay, the lender will end up taking a loss.