Advantages and Disadvantages of a Promissory Note

A promissory note is a relatively informal, but still legally binding, loan commitment. Simplicity and flexibility are two primary advantages of using a promissory note in lieu of a loan. However, promissory notes aren't as beneficial in complex situations where a more formal loan agreement is necessary.

Promissory Note Advantages

A promissory note is sometimes referred to as an "IOU." but it is a legal form just like a loan. You can use it for obligations ranging from inter-family loans to mortgages. Student loans, bank loans, commercial loans and vehicle loans are other common uses.

The simplicity and straightforward nature of a promissory note make it most beneficial when a loan has simple payment terms. You don't need to record nearly as much detail or have as lengthy of a document with a promissory note. Minimal elements to include are the loan amount, interest rate and repayment schedule, according to Equifax. It's helpful to add a few additional details, such as the property address and phone numbers of the parties involved. With basic inter-family loans and other small-value notes, you don't need a thorough legal review of the document. Instead, have a CPA, financial professional or Notary "witness" the signing of the note.

Promissory Note Disadvantages

Since the primary value of a promissory note is simplifying the loan process, it isn't as beneficial for more complex situations. A loan agreement is necessary when you have a more complicated loan or you want greater protection against borrower default.

Another risk to novice borrowers is that savvy lenders may hide unfavorable terms in the fine print of a longer promissory note. Before signing any type of legally-binding loan document, both parties need to thoroughly read and understand all critical terms of the document. With a real estate note, one tactic used by lenders is tucking early payment penalty details into obscure sections of the note. This penalty means the borrower may have to pay a lump sum penalty when trying to pay off the loan before the mortgage term is completed. Time-consuming legal reviews sometimes are necessary with more detailed notes.