Unsecured Promissory Note: Everything You Need to Know
An unsecured promissory note is a type of promissory note where there is no protection for an unpaid debt.3 min read
An unsecured promissory note is a type of promissory note where there is no protection for an unpaid debt.
What Are Unsecured Promissory Notes?
A promissory note is an important part of an agreement. This document establishes the duties and rights of the parties in the contract and must written, dated, and signed.
In these agreements, one party agrees to pay the other party a specific amount. Depending on the terms of the promissory note, payment can be made in several ways:
- On demand.
- At a point in time specified by the payee.
- In installments.
The amount that must be given to the payee may also include interest that will be based on the principal unpaid amount described in the note. When writing a promissory note, the note can either be unsecured or secured. With an unsecured promissory note, there is no security for debts that aren't fully paid.
Using an unsecured promissory note means that the lender will not receive anything in return if the borrower is unable to make the required payment. Lenders who decide to use an unsecured promissory note should consider the credibility of the borrower before signing the agreement. There is no collateral backing for an unsecured promissory note.
In these circumstances, the person who holds the note can pursue compensation with the debt collection process. This process can include:
- Offering the payee a debt settlement agreement.
- Sending the payee a letter demanding payment.
- Suing the payee in small claims court.
Although promissory notes can use different payment structures, it's common for payments to be required in either monthly or weekly installments. Payments must be made by a certain date, and there usually will not be penalties for prepayment. With a secured promissory note, the borrower is required to put up some form of collateral, usually property or assets. If the borrower fails to pay back the lender, they will receive the collateral to make up for the lost payments.
Loans are typically accompanied by unsecured promissory notes. When issued by an individual lender, a promissory note can be called a bank note. The reason to include a promissory note with a loan is to detail how a person will pay back the money that they have borrowed from a lender. Whereas loans can be very complicated documents, promissory notes are usually very simple.
All promissory notes use a similar structure, and they typically aren't longer than a single page. Some of the general terms that you may find in a promissory note can include:
- A promise from the borrower to repay the money they have been loaned.
- The amount that has been loaned and the interest rate.
- A description of how frequently payments will be made and who will receive the payments.
- The amount of the payments.
- Additional fees that may be required.
- Procedures for late payments or defaults.
Once both parties agree to the terms of the unsecured promissory note, the parties, as well as witnesses, will sign the note. The note will also need to be notarized. At its most basic, an unsecured promissory note is a statement that documents a loan transaction.
Secured vs. Unsecured Promissory Notes
Both borrowers and lenders need to understand the differences between secured and unsecured promissory notes. Because these two types of promissory notes often appear identical, it can be hard to detect the differences if you're not familiar with them already. There is, however, one crucial difference between secured and unsecured promissory notes.
Unsecured promissory notes are promises that a borrower will pay back a lender a certain amount. The promises made in these notes, however, are not backed by anything concrete, meaning the lender is taking the borrower's word that they will actually make the payments described in the note.
It is sometimes possible to add terms to a promissory note that are meant to secure the agreement. Promissory notes can be secured using a financing statement, deed of trust, or a mortgage. If a promissory note includes these terms, then it is a secured promissory note. So, the inclusion of collateral is the only real difference between secured promissory notes and unsecured promissory notes. Different types of assets can be used as collateral in a secured promissory note, including bank accounts, cars, and real estate.
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