If I want to loan my friend money, how do I guaranty I am repaid with a promissory note?
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Answer:
Quite simply, a promissory note is a promise to pay or IOU. It is a formal commitment (also known as a loan agreement or contract) between two parties that is usually necessary when money is borrowed and lent between them. All business loans secured from a bank or other lending institution have some sort of promissory note, but they are also recommended for loans between two individuals (even if the loan is between family members or close friends) to avoid any misunderstandings or possible legal troubles.
A personal loan to help with a mortgage balance, probably is not the kind of loan that could be secured by collateral (i.e. the house). Therefore it would be known as an unsecured note.
A promissory note should have several essential elements, including the amount of the loan, the date by which it is to be paid back, the interest rate, and a record of any collateral that is being used to secure the loan. Other interest-rate options, like discounting or compensating balance requirements, can also be included. When the promissory note is discounted, the interest is taken off the principal amount at the beginning of the loan. The borrower pays back the entire amount, even though he only received the principal minus the interest. This practice is not very common because it is a higher effective rate of interest than the stated rate for the borrower. A compensating balance is usually required for large loans or lines of credit. It requires that the borrower maintain an account with a specified minimum level account balance at the lending institution (usually a bank). This account balance earns little or no interest and also raises the effective interest rate of the loan. Default terms (what happens if a payment is missed or the loan is not paid off by its due date) should also be spelled out in the promissory note.
When signing a promissory note, both the lender and the person receiving the loan should be fully aware of the note's language. One obvious way to do this is to read the promissory note carefully and in its entirety before committing a signature to it. If there are any questions or confusion regarding the contents of the promissory note, a certified public accountant (CPA) or lawyer should be called on to make sure everything is understandable. When a casual promissory note is drawn up between two individuals, the IRS has a required interest rate. A CPA can help determine if the interest rate stated in the promissory note is too low and if it will result in penalties or automatically be raised. If the loan is interest free, the IRS may consider it a gift and require that a gift tax be paid on it.
Unfortunately even the best drafted promissory notes cannot guaranty repayment of the loan.
If the borrower fails to pay as required under the note, and there is no one else to hold responsible for the repayment (such as a guarantor), then the lender must sue the borrower pursuant to the promissory note. A successful lawsuit would award the lender a judgment with which he/she can use the resources of the court to pursue collection of the judgment.