Understanding Promissory Notes

Promissory notes constitute a promise to pay some type of loan. Every time you take out a student loan or buy a stereo system through a finance company, you sign a promissory note that outlines the contractual terms of the loan.

In the past, people

exchanged goods in real time, meaning that when they bought something, they gave something in consideration for what they were receiving. Originally, it was a barter that involved the exchange of goods. Once people began using money and buying goods that they couldn't pay for immediately, they started signing pieces of paper that promised to pay the remainder of the debt. One of the early forms of promissory notes was an IOU.

IOUs were pieces of paper that generally listed the amount owed and the signature of the person owing the money. IOUs differed from promissory notes in that an IOU simply acknowledged the existence of a debt, but usually made no provisions for paying it back.

Also known in accounting terms as a note payable, a promissory note is a contract that lays out the terms and conditions for the repayment of a debt. A promissory note should describe in detail everything involved in the repayment. In addition to the basic provisions of a contract, a promissory note includes the following information regarding the debt:

• The principal amount of the debt
• Amount and term of interest charged on the debt
• Schedule of payments, including dates, amounts, and late charges
• Description of any collateral used to guarantee the debt
• Ramifications if the debt is not repaid as specified in the promissory note

Visit the AllBusiness.com Forms and Agreements section to view sample Promissory Notes.