Promissory note: Definition and how it works

A promissory note, sometimes called a promise-to-pay agreement, is a written promise to repay a certain amount of money within a specific period of time. A promissory note might need to be signed by borrowers who take out student loans and mortgages. And businesses sometimes use these documents to raise funds.

Learn more about promissory notes and how they work.

What you’ll learn:

• A promissory note typically states that a borrower promises to repay a lender a certain amount of money by a specific date.

• These notes are legally binding and may include loan terms—like the principal amount, interest rate and payment schedule.

• Promissory notes may be used when you get a student loan, mortgage or loan from a family member or friend.

• Both parties are typically required to sign the note, but exact requirements may vary.

A promissory note is a written agreement to pay back money. These legally binding loan agreements typically include debt repayment terms—like payment schedules and interest rates. They can act as a contract between two parties: One party requests funds and promises to repay the other party when asked or on a set date.

Although requirements may differ by state, promissory notes typically include the following:

• Names, addresses and signatures of the borrower and lender

• Principal loan amount

• Interest rate

• Lump sum or installment payment amount 

• Payment due date and schedule

• Late fees or other penalties

A promissory note acts as an IOU that outlines the amount being borrowed, the interest, how it will be repaid and the due date. A borrower is expected to follow the repayment terms outlined in the promissory note. If a borrower violates the terms of a valid promissory note, the lender may have the right to recover their money.

Promissory notes may be secured or unsecured. A secured promissory note requires collateral—typically property—to back the debt. On the other hand, unsecured promissory notes don’t require collateral.

Repaying a promissory note can be done in several ways, but each approach involves repaying the principal plus any interest. Methods for repayment can include:

• Installment note: You repay the loan in regular payments, usually monthly. Each payment may include the principal and interest.

• Open-ended note: You can borrow, repay and borrow again up to a certain limit and date. 

• Simple note: You pay back the entire loan in a lump sum by a specific date. 

• Demand note: The lender can request repayment at any time.

Borrowers may need to sign promissory notes for a variety of debt agreements. These documents could offer borrowers and lenders some protections if either party doesn’t follow the outlined terms.

When someone buys a home with either a mortgage or deed of trust, they may need to sign a promissory note, which outlines the mortgage terms and conditions. It’s typically signed at closing and may include the loan amount, loan term, payment amount, due date and more.

If a borrower doesn’t comply with the promissory note terms, the lender may have the right to foreclose on the property.

Borrowers may sign a promissory note when they take out private or federal student loans. Federal student loan borrowers may sign a Master Promissory Note (MPN) that can be applied to multiple loans. 

By signing the MPN, a student agrees to repay all loans according to the terms and conditions of the MPN. Federal student loan MPNs are currently valid for up to 10 years.

If someone doesn’t qualify for a traditional loan, like a personal loan from a financial institution, an option might be to borrow money from a friend or family member. In this case, a valid, notarized promissory note can make the agreement legally binding and help protect both parties’ interests.

But family or friends who lend money and use a promissory note might not have the same protections or enforcement methods as a traditional financial institution to recoup the funds.

Businesses sometimes use promissory notes for short-term financing. These notes can carry investment risks and may need to be registered with state or federal agencies—like the Securities and Exchange Commission.

Here are answers to some frequently asked questions about promissory notes.

A promissory note is a legally binding promise to repay a debt. These agreements could be used for student loans, mortgages, loans between friends and family, and more. 

Promissory note laws vary by state, but they typically include the loan amount, loan terms and signatures from both the lending and borrowing parties. If the promissory note doesn’t meet certain requirements, it may become invalid.

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