A promissory note is a written, signed and dated contract that establishes the rights and duties of the parties to the agreement. The agreement’s maker agrees to pay a certain amount of money on demand, at a specified time or in installments to the payee or holder. The amount due may include a particular amount of interest on the note’s unpaid principal amount. A promissory note may be secured or unsecured.
Unsecured Promissory Note
An unsecured promissory note is not backed by collateral. In this case, the maker does not grant the holder an interest in property to assure the payee against default risk -- the risk the he won’t repay the note. Instead, if the payee fails to adhere to the note’s terms, the holder can seek recourse through a debt collection process, such as entering into a debt settlement agreement, issuing a demand letter or filing a claim in a small claims court.
Secured Promissory Note
A promissory note may include terms that secure the agreement by a mortgage or deed of trust or a financing statement, which is a security agreement for personal collateral. Under the a secured promissory note, the maker grants the payee an interest in a specific property to collateralize the loan, or provide the payee assurance against default risk -- the risk the note will not be repaid. If the maker doesn’t repay the loan according to the note’s terms, the payee can take possession of the property that secured the note as a means to recover the note’s unpaid principal, interest, fees and expenses.
Most of the terms that you can include in an unsecured note or a secured note are the same. For example, the note can specify the holder’s right to order the note’s payments to be paid to someone other than the holder, late payment penalties and a provision for the payment of attorney fees and costs in the event of a legal collection action.
The primary difference between an unsecured note and a secured note is that a secured note's terms provide the payee assurance against default risk, an unsecured note does not. If a maker of a secured note fails to adhere to the note’s terms, the payee can take possession of the property that secures the note. In the case of an unsecured note, the payee’s only recourse for nonpayment is the debt collection process. A secured note will specify the collateral that secures the amount of borrowed by the note maker. The holder has an interest in the property until the note’s principal, interest and any related fees and expenses are repaid.