What is a Personal Promissory Note?
A personal promissory note is a written document that evidences a loan of money to a family member or friend. While promissory notes generally come into play during a business transaction, like the purchase of real estate, it is also important to protect yourself when a loan is made to a family or friend.
The promissory note will serve as evidence that someone promised to pay you money back at a future date. You should include the terms of the loan in the promissory note and understand your legal rights surrounding the note.
What Needs to Be Included on a Personal Promissory Note?
In order for the personal promissory note to be valid and binding, several things should be included. First, the note should clearly identify the parties to the loan by their legal names. All parties must sign the note to make it binding.
The amount of money loaned, repayment terms, date the loan was made, and end date should also be included. Some things to consider are whether you want interval payments (promise to pay a set amount every month) or an end date (promise to pay the loan off entirely by a certain date). These are just some examples of repayment options and other arrangements would also be acceptable.
Another thing that you will need to decide is whether you are charging interest on the loan. This can be a difficult subject to bridge, as many people will not want to charge interest to a family or friend. If you do decide to charge interest on the note, then interest rate must be clearly articulated in the note. However, keep in mind that interest is not required for a valid promissory note.
If there is no interest on the loan, then it still may be put onto it for tax purposes. This means you will have to report the projected interest as income, even though it was not charged or collected. However, most of the time you can bypass this by reporting it as a gift, which would be considered tax-free. A tax lawyer or other tax professional can advise you on how to handle this.
Keep in mind that the majority of loans made to family and friends are unsecured, meaning that they will not identify collateral for you to take if the borrower fails to repay the money. However, if you are securing the loan then make sure to include this in the personal promissory note.
Your state may also have specific requirements for what needs to be included in a personal promissory note. Make sure to familiarize yourself with this before drafting the note.
Can I Sell a Personal Promissory Note?
One common question is whether you are able to sell personal promissory notes to third-parties to collect upon the debt. This happens often with promissory notes that are not personal-based, especially with mortgages.
Generally, most people will not sell personal promissory notes because that could create more tension between family and friends. However, if you are dealing with nonpayment and the relationship is strained, then you may want to look into your options for selling the debt to a third-party. Just remember that your cut of the debt will be lower if collected because the third-party will take a fee.
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