Promissory notes and loan agreements are documents that outline the details of a loan. They both outline the terms of the loan, including repayment terms, and act as legal documentation with remedies should a loan go unpaid.
Although promissory notes and loan agreements are similar, there are key differences between the two.
For example, promissory notes are typically created between you and someone you have a business or personal connection with. Loan agreements are typically created between you and the financial institution providing the loan. Read on to learn more about the differences between promissory notes and loan agreements.
What Is a Promissory Note?
In the simplest terms, a promissory note is a note in which you promise to pay someone. If you borrow $5,000 from your parents, friends, or a colleague, they’ll likely want something in writing that shows you acknowledge that you’ve received the loan and you agree to pay it back at some point.
Terms on promissory notes are usually fluid. You may agree to pay the loan back in one lump sum or over a series of installment payments. These notes don’t typically include remedies like late or return payment fees that you would find on traditional loan agreements either.
Promissory notes should include:
- The loan amount
- The date on which the loan should be repaid (if a lump-sum payment is required)
- The dates on which installment payments should be made (if installments are allowed)
- Interest or fees the borrower must pay to access the money
- Any other terms the parties involved agree upon
What Is a Loan Agreement?
A loan agreement is a more traditional legal document that outlines the details of a loan, much like a promissory note. The difference is in the details. You would normally sign a loan agreement with a financial institution; there’s a strong chance you’ve already done so in the past.
Any time you get an auto loan, mortgage, or even a personal loan through traditional means, your lender will request that you sign a loan agreement.
Loan agreements typically include:
- The loan amount
- The date on which installment payments are expected and
- The amount of the installment payments
- Details about the collateral (if any)
- The interest the borrower is expected to pay
- Any and all applicable fees
- Any and all applicable terms
- Legal remedies the lender may take if the borrower should default on the loan
Promissory Note vs. Loan Agreement
Promissory notes and loan agreements are somewhat similar documents. However, when you dig into the details, you’ll find more differences than similarities.
Differences Between Promissory Notes & Loan Agreements
Some of the most significant differences between promissory notes and loan agreements include:
- Collateral: Most loan agreements center around loans with collateral, while promissory notes are only secured by the borrower’s word.
- Repayment Terms: Promissory notes might require lump-sum repayment. However, in some cases, installment payments are allowed. In most cases, loan agreements come with monthly installment payments.
- Parties: Most loan agreements are signed between a borrower and a financial institution, while promissory notes are signed between friends, family, and colleagues. This means promissory notes are easier to adjust if all parties agree.
- Failed Payments: Promissory notes typically don’t give the lender a remedy if the borrower fails to pay. Loan agreements give the lender the opportunity to foreclose on the collateral if the borrower doesn’t pay as agreed. As a result, the only remedy for promissory note holders may be to file a lawsuit in an attempt to collect.
- Legality: Promissory notes are only legally binding on the borrower’s side of the note. Loan agreements legally bind all parties involved.
Similarities Between Promissory Notes & Loan Agreements
Although there are plenty of differences between promissory notes and loan agreements, there are a couple of similarities that are worth mentioning. Those include:
- Loan Amount: Promissory notes and loan agreements both clearly outline the total principal amount of the loan.
- Payment Terms: Promissory notes and loans both clearly outline how the loan is expected to be repaid.
- Interest & Fees: Both types of agreements clearly state the interest and fees the lender expects the borrower to pay.
- Enforceability: Promissory notes and loan agreements are both legally enforceable. That means if the borrower fails to pay the lender as agreed, the lender can decide to settle things in court.
Although promissory notes and loan agreements are similar in some ways, they’re also very different. It’s important to understand these similarities and differences before entering either type of agreement, whether you’re the borrower or the lender.
Cited article sources
- Dept.org (Updated February 23, 2022). “What is a Loan Agreement” https://www.debt.org/credit/loans/contracts/