Loan Agreement Vs Promissory Note

There are countless occasions in life when you must borrow or lend some cash to maintain your way of life without having to make concessions regarding money. There are numerous ways to do this, each with their own distinct terms and conditions.

Promissory notes and loan agreements are two examples of these. While they may appear to be performing essentially the same task, there are a number of differences between them that you should take into account before selecting one over the other.

In order for you to select the option that is best for you, we will explain the differences between each of them in detail here in this article. Let’s dive right in.

A loan agreement contains specific details about the loan, how much is to be paid back, interest rates, penalties if the loan is not repaid and other contractual terms that the lender and borrower agree to. Promissory notes are more informal arrangements in which a borrower promises to repay the lender for a loan.

What is a Promissory Note?

A promissory note is essentially a written agreement between two parties outlining the terms under which one party lends the other a specific sum of money. The document is typically negotiable, which means that with the consent of both parties involved, the amount that will be returned over time or the period over which it will be returned may be altered.

It is essentially a promise to repay a person you borrowed money from of a certain amount. There could, however, be different names to refer to it. It may also go by the names Payment on Arrival, Payment on Demand, or IOU. However, the main procedure always stays the same. One thing to keep in mind is that a promissory note is typically used for a limited number of loans because it is not a very formal process. To quickly and easily download the Promissory Note, use the tool provided by Form Pro.

The following are some of the principal components of a promissory note:

  • Amount of loan given to the borrower.
  • Maturity date.
  • Interest rate (if any).
  • Penalty for late payment.
  • The format, however, can vary from note to note and is largely dependent on the party. Some of the aforementioned sections may be skipped if the parties intend to have a rather informal note and the amount is also not that large. However, most promissory notes follow the format given above.

    Instances When a Promissory Note Can Be Used

    Promissory notes are typically used when the amount of money is not very large. Also, a person who is close to you is receiving the loan of the money. For example, your cousin or your relative. This is due to the fact that you and the other party have a degree of trust and don’t want to enter into a legal contract because you both understand that, no matter what happens, you will eventually get your money back without the need for any legal action.

    The adaptable return routine is a crucial time when you can use this. As the promissory note does not involve a legal agreement, the two parties with mutual understanding can change the dates or the regular installment themselves when they are aware that it is not very official and there is a good chance that the date when you’re supposed to get the money back is not set in stone.

    What is a Loan Agreement?

    Although a loan agreement serves a purpose very similar to that of a promissory note, it does so in a more formal manner. The main distinction here is that the loan agreement is much more detailed than a promissory note, even though the fundamental principles are the same and the primary goal of the document is to provide an agreement between the two parties regarding when to return or obtain the money from the other party.

    Usually, the loan agreement provides a complete set of information about the understanding between the parties. The terms of the loan are specified in detail, and each loan document is unique from the others. Based solely on these facts, it is possible to estimate the level of detail in every matter.

    The loan agreement majorly comprises of four sections. The general rule of four sections is still followed even though each note is distinct depending on the specifics of that instance. Below mentioned are those four sections.

    Definitions & Interpretation

    This section serves as the loan agreement’s jargon dictionary and provides definitions for all of its terms. This includes all the vocabulary that is specific to a given field or is unusual and unfamiliar to the general public.

    I Financial / Commercial Details

    The section includes the total amount given as a loan, the amount to be repaid, the deadline for payment, and, if applicable, the interest being charged on the loan. Contrary to a promissory note, where they are essentially tentative and negotiable, the dates in this situation strictly adhere to each other.

    This section outlines all the information unique to this transaction. This includes a complete identification of the borrower, along with his private information. Additionally, a thorough discussion of the circumstance in which the borrower fails to pay back the agreed-upon sum is included.

    Types of Loan Agreements

    All of the clauses that are stated in the loan document’s final section are clearly defined there, setting the standard.

    In addition, people typically use one of two main types of loan agreements. The first is an unsecured loan agreement, meaning there is no security in case the borrower defaults or, to put it another way, doesn’t pay back the money as agreed. In this situation, the lender is powerless to take any action, and the loan agreement serves no purpose for him to recover his money.

    However, the secured loan agreement, which is the other type and is more dependable, By using this type of contract, the lender could legitimately take possession of the borrower’s property in the event that the borrower defaults and doesn’t pay back the loan on schedule.

    Loan agreements are undoubtedly preferable when borrowing a sizable sum of money. Additionally, it is advised to use it if you want to finalize the transaction but cannot personally rely on the other party. The benefit of using the loan agreement in place of the promissory note in this situation is that you can unwind and not have to worry about getting your money back. You will always get your money back, regardless of what happens.

    An illustration would be if you wanted to lend a large sum of money to a family member. Say, he wants to buy a vehicle or a house. You must ensure that your money is secure because the sum involved is quite large. Therefore, it is very clear that the loan agreement should be followed here because using a promissory note could be very risky.

    Takeaway: Which Is Better to Use?

    The legal structure to use when making a loan to someone is heavily influenced by the amount being lent as well as your relationship with the borrower. To avoid potential legal problems, it is preferable to use a promissory note if the amount is not excessive and the relationship is reliable.

    However, use a secured loan agreement to ensure your money is safe with the borrower if the amount is substantial and the relationship is not entirely trustworthy. Because you will be legally entitled to receive your money back in some capacity even if the borrower does not repay as agreed.

    Last but not least, remember that no matter which strategy you decide on, you should always make sure that the legal form used is accurate and reflects the interests of both parties.


    Do you need a promissory note if you have a loan agreement?

    A promissory note is not always required by law to serve as proof of a promise to pay, and it is also not always forbidden to include one in a loan or credit agreement. Promissory notes are typically not negotiable instruments, despite the fact that this is sometimes believed to be the case.

    Why have both a promissory note and a loan agreement?

    They both usually cover the consequences of non-payment. A promissory note or loan agreement would not be complete without certain details regarding what will happen if the borrower fails to repay the lender. Without this critical information, neither document would be worth much!.

    Is a loan agreement legally binding?

    A personal loan contract is a legally binding document regardless of whether the lender is an institution of higher learning or an individual. If you breach the contract, the results are the same.

    Is a promissory note considered a loan?

    You will require a promissory note to set forth the terms of any loans or borrowings you make. Promissory notes are legal lending documents. You’ll need one to specify the loan’s terms if you’re going to lend someone money.