A promissory note is a way to formally set terms for repayment of a loan. Unlike an IOU, which only states that there is a debt, a promissory includes the terms of repayment. Usually these terms will include any interest rate, and how and when the debt is to be paid off (whether in payments or all at once). Defaulting on a promissory note can often result in serious consequences, especially if there is an acceleration clause included.
Entering into a Promissory
Anyone who can enter into a contract can agree to a promissory. This means that minors cannot sign a promissory, nor can those who are considered legally mentally handicapped. All terms of the loan must be legal. For instance, a promissory note whose interest rate is higher than the state usury laws allow would not be considered valid.
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An acceleration clause can be included in the promissory note to protect against a borrower defaulting on the loan. In most cases, the acceleration clause states that if a borrower misses a payment the entire amount of the loan is due, no matter what the initial terms of repayment. If, for example, a borrower is to repay $100 per month for one year on a $1,200 loan, and did not make his payment in the third month, the entire balance of $1,000 would immediately fall due.
Costs of Collection
If a clause to this effect is part of the initial terms of the promissory note, it means that the borrower is responsible for all fees pertaining to the collection of the debt should the borrower default. This usually means that the borrower will have to pay for the lender's court and attorney fees if a lawsuit is necessary to receive payment on the note.
Often in the cases of a large loan, lenders will "secure" the loan with a lien on a home or other significant property. If such a lien exists, the property in question can be used as collateral for the loan, and the lender can sue to sell the property to regain their money in the case of default.
Right of Set Off
In the cases where the lender on a promissory note is a bank, and the borrower has a checking or savings account with that bank, the bank has the right to use the money in the borrower's account toward the loan in case of default. If, for example, the borrower has $1,000 in his checking account, and defaults on a promissory note with $800 remaining, the bank would take the $800 from the checking account to apply toward the note. If, as is more likely, the borrower had $1,000 in his account and defaulted on a promissory note of $5,000, the bank would put the $1,000 toward the balance on the promissory note and the borrower would still owe $4,000.