Demand Note vs Promissory Note: Everything You Need to Know
Demand note vs promissory note are both ways to provide a written agreement from a lender to a borrower.3 min read
Demand note vs promissory note are both ways to provide a written agreement from a lender to a borrower. A demand note means that the balance owed does not have to be repaid until it is 'demanded' by the lender and the note does not have a specific end date listed. When payment is requested, a time period will be given for repayment. A promissory note, in contrast, can have the option for payment to be 'on demand' or at a specified date. A demand note is not required to show cause notice to be given to a borrower who is delinquent, unlike a mortgage loan.
Promissory Note Details
A promissory note is repaid in full at the end of the term listed on the note. There are four methods of repayment including:
- Lump sum payment- This means the entire note is paid in one payment at the end of the term.
- Interest only- Meaning the regular payments are applied to only the interest that is being accrued, not on the principal amount.
- Interest and Principal repayment- Funds are being applied to both the interest being accrued and the principal amount of the note.
The option for the borrower to repay the remaining principal without penalty is possible if the lender approves. The lender may not approve this option if the note is seen as an investment. In this case, they can impose a penalty to avoid losing income when they reinvest the money.
The lender can also request a form of collateral as an insurance policy if the borrower defaults on the note. This will require legal action but will help the lender recoup any lost funds. The collateral does not have to match the amount of the note; it can be any amount. If the collateral amount is less than the note and the borrower defaults, the lender may seize the collateral, then sue for the rest of the amount. Inversely, if the collateral is more than the note, the excess amount received from the sale of the collateral must be returned to the borrower.
In some cases, promissory notes can be resold at a discounted rate, including corporate bonds and retail investment loans. The new owner of the note can receive the total face-value amount on the date of maturity or a smaller amount if it is before the due date. The new owner of the note will frequently receive interest, along with the appreciated difference in the price.
A promissory note may also contain additional terms such as late penalty charges, attorney fee provisions, and other note specific requirements.
The date of when the promissory note is signed does not have to be filled in right away. A blank line can be put in the contract and the date can be entered after the printing of the document. A notary public or witness is also, in general, not required when signing the promissory note. For some jurisdictions, this is not the case and a notary public of witness must be present when the promissory note is signed.
Whether it is required or not, a witness to the signing is recommended to help if there are issues with the borrower repaying the note. At the very least, the borrower signing should be witnessed. If you want to cover yourself in case of legal issues later, have a notary public witness both the lender and borrower signing the note, then have them notarize the signatures.
Demand and Time Instruments
A promissory note is how a borrower shows their intent to repay the note. All rules associated with promissory notes are from the Uniform Commercial Code Article 3 (Article 3). This stipulates the notes can act as instruments of demand or time.
- A demand instrument holder determines when they should expect payment. This timeframe must include a timeframe or date for repayment to take place.
- A time instrument has the option to use an acceleration clause that allows the holder to move the payment date forward.
If either a demand or time instrument is used, it may be an indication that the borrower's credit rating has dropped.
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