Promissory note explained

Most people will borrow money at some point in life, and some will lend money. While an IOU might suffice for smaller amounts, a more binding agreement can be helpful when dealing with larger sums. With a promissory note, two parties formalize the lending of money. Through this legal agreement, both the borrower and the lender consent to clearly defined repayment terms. Promissory notes can be used for a variety of purposes, including personal and commercial transactions.

Here’s a guide to common types of promissory notes, how to create one and when they may be a good fit for borrowing or lending money.

Related: 10 personal finance basics

Intro to promissory notes

Put simply, a promissory note is a written promise to pay someone a certain amount by a specified time. The type of promissory note and agreement between the issuer and payee dictate the payment schedule and amount. Generally, promissory notes include the principal amount, interest rate, date and place of issuance, and signatures from the lender and borrower. There may also be provisions for late fees and recourse if a borrower defaults. Similar to loans, promissory notes may be secured or unsecured. Unsecured notes are issued based on the borrower’s ability to repay, whereas secured notes use collateral such as real estate or a vehicle.

A promissory note may be issued by a financial institution, but this financing is commonly provided by individuals or businesses, too. Essentially, promissory notes allow anyone to act as a lender, which can be useful for creating legal documentation of a lending agreement between family members and friends.

Private vs. federal student loans

Paying for College — Getting accepted to college may seem exciting on the surface, but in reality, it’s only half the battle. After you’ve filled out your applications and decided on a school, you’ll then need to fund your college education (which can quickly dampen the excitement of getting accepted).

There are a few different options when it comes to financing a college education, and it’s important to understand the pros and cons of each. Then, you’ll likely be better able to develop a funding strategy that fits your unique situation.

Depending on your academic qualifications, you may have been awarded scholarships or grants, which is funding that won’t (typically) need to be repaid. Any expenses not covered by a scholarship will need to be financed, often through a combination of work-study, personal funds, or student loans.

It is fairly common for college students to take out student loans to finance their education. There are two main types of student loans: private student loans and federal ones.

We’ll compare and contrast some of the more popular features of both private and federal student loans and explore some features that can help you determine what makes the most sense for your financial situation.

**Related:** A guide to private student loans

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Subsidized vs Unsubsidized Loans — Federal loans can be subsidized or unsubsidized. If you’re an undergraduate student and you have a certain level of financial need, you may qualify for a subsidized loan. The amount of money you qualify for will be determined by your school. They’ll also determine how much money you should receive in subsidized loans, if any.

If you are granted a subsidized loan, the U.S. government will cover, or subsidize, the cost of accrued interest on the loan while you are a full- or half-time student.

Your interest payments are also covered with subsidized loans during the six-month grace period after graduation as well as during any periods of loan deferment.

If you receive unsubsidized federal loans, you will not need to demonstrate financial need when applying and, as with subsidized loans, your school will determine the amount you can receive, based on what it will cost you to attend.

But with unsubsidized loans, you are responsible for the principal amount of the loan as well as any interest that accrues throughout the life of the loan.

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Direct PLUS Loans for Parents and Graduate Students — Direct PLUS Loans are another source of federal student loan funding. To qualify for graduate PLUS Loans, you need to be a graduate-level or professional student in a program that offers graduate or professional degrees or certifications and be attending college at least half-time.

Or parents can also apply for a parent PLUS loan if they’re the parent of a dependent undergraduate student attending an eligible school at least half-time. “Parent” can be defined as biological or adoptive — or, under certain circumstances, you can be a step-parent.

To obtain a Direct PLUS loan, you cannot have an adverse credit history (you can learn more about that here). Plus, you (and, if applicable, your dependent child) must meet the general eligibility requirements for federal student aid.

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More About the FAFSA — If you plan to apply for any of these types of federal loans, you’ll need to fill out the FAFSA form. Be aware of your state’s deadline — FAFSA funding is determined on a rolling basis, so the sooner you can apply, the sooner you may qualify.

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Benefits of Federal Student Loans — First off, you won’t be responsible for making student loan payments while you are actively enrolled in school. Your repayment will typically begin after you graduate, leave school, or are enrolled less than half-time. Interest rates on federal student loans made after July 1, 2006 are fixed and are typically lower than interest rates on private student loans.

And depending on the type of federal loans you have, the interest you pay could be tax deductible. Aside from Direct PLUS Loans,credit history doesn’t factor into a federal loan application. When it comes to federal student loan repayment, there are several options to choose from, including several income-driven repayment plans.

And if you run into difficulty repaying your federal student loans after graduation or when you drop below half-time enrollment, there are deferment and forbearance options available.

These programs allow qualifying borrowers to temporarily pause payments on their loans should they run into financial issues, but interest may still accrue. The loan type will inform whether a borrower qualifies for deferment or forbearance.

Borrowers can contact their student loan servicer for more information on these programs.

Qualifying borrowers can also enroll in certain forgiveness programs, such as Public Service Loan Forgiveness (PSLF). These programs have strict requirements, so borrowers who are pursuing forgiveness should review program details closely.

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The CARES Act and Federal Student Loans — The CARES Act, passed in March 2020 in response to COVID-19, includes provisions to help borrowers with federal student loan repayment. The bill temporarily pauses payments on most federal student loans, without interest, through the end of September 2021.

Additionally, the CARES Act suspends involuntary collections and negative credit reporting during the same time period.

While required payments are paused, borrowers are still able to make payments on their loans if they so choose. 100% of payments made during this time will be applied to the principal balance of the loan.

Borrowers enrolled in forgiveness programs will not be impacted by the nonpayment of their loans during this time. The Education Department will consider this time period as if the borrower had continued making payments.

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Private Student Loans — Private student loans are not funded by the government. To apply for them, you can check with individual lenders (banks, credit unions, and the like), with the college or university you’ll be attending, or state loan agencies.

Because these loans are available from multiple sources, and each will come with its own terms and conditions. So, when applying for private student loans, it’s important to clearly understand annual percentage rates (APRs) and repayment terms before signing as well as the differences between private vs federal student loans.

Since private student loans are not associated with the federal government, their repayment terms and benefits vary from lender to lender. Some private loans require payments while you’re still attending college.

Unlike federal loans, interest rates could be fixed or variable. If you are applying for a variable-rate loan, it’s a good idea to check to see how often the interest rate can change, plus how much it can change each time, and what the maximum interest rate can be.

When applying for a private loan, the lender typically reviews your financial history and credit score, which means it may be beneficial to have a cosigner.

Again, be sure to ask your lender about repayment options in addition to any deferment or forbearance options.

These will all vary by lender, so it’s important to understand the terms of the particular loan you are applying for.

Private loans can help fill the monetary gap between what you’re able to cover with grants, scholarships, federal loans and the like, and what you owe to attend college. It’s never a bad idea to take the time to do your research, shop around, and find the best loan options for your personal financial situation.

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Determining Whether a Student Loan is Federal or Private — To find out if the student loan you have is a federal student loan, one option is to check the National Student Loan Data System (NSLDS).

This database, run by the Department of Education, is a collection of information on student loans, aggregating data from information about student loans, aggregating data from universities, federal loan programs and more.

Borrowers with federal student loans can also log into My Federal Student Aid to find information about their student loan including the federal loan servicer.

Private student loans are administered by private companies. To confirm information on a private student loan, one option is to look at your loan statements and contact your loan servicer.

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Options for After Graduation: Consolidation vs Refinancing — After graduation, depending on one’s student loan situation, borrowers may wish to consider consolidation or refinancing options to combine their various loans into a single loan.

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What is Student Loan Consolidation? — The federal government offers the Direct Consolidation Loan program that allows borrowers to combine all of their federal loans into one consolidated loan.

Loans consolidated in this program receive a new interest rate that is the weighted average of the interest rates of all loans being consolidated — rounded up to the nearest one-eighth of a percent.

This means that the actual interest rate isn’t necessarily reduced when consolidated. If monthly payments are reduced, it is most likely because the repayment term has been lengthened.

Additionally, only federal student loans are eligible for consolidation in the Direct Consolidation Loan program.

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What is Student Loan Refinancing? — Borrowers with private student loans might consider refinancing their loans. Essentially, refinancing is taking out a new loan. Depending upon individual financial situations, applicants could qualify for a lower interest rate through refinancing.

When an individual applies to refinance with a private lender, there is typically a credit check of some kind. Each lender reviews specific borrower criteria, which varies from lender to lender, which influences the rate and terms an applicant may qualify for.

But what if you have both federal and private loans? If you combine your federal loans through the Direct Consolidation Loan program and refinanced your private loans, you’d still have two payments.

**Learn more:**

**The differences in direct vs. indirect student loans**

**How to apply for student loans**

This article
originally appeared on *SoFi.com* and was
syndicated by *MediaFeed.org*.

IF YOU ARE LOOKING TO REFINANCE FEDERAL STUDENT LOANS PLEASE BE AWARE OF RECENT LEGISLATIVE CHANGES THAT HAVE SUSPENDED ALL FEDERAL STUDENT LOAN PAYMENTS AND WAIVED INTEREST CHARGES ON FEDERALLY HELD LOANS UNTIL THE END OF SEPTEMBER DUE TO COVID-19. PLEASE CAREFULLY CONSIDER THESE CHANGES BEFORE REFINANCING FEDERALLY HELD LOANS WITH SOFI, SINCE IN DOING SO YOU WILL NO LONGER QUALIFY FOR THE FEDERAL LOAN PAYMENT SUSPENSION, INTEREST WAIVER, OR ANY OTHER CURRENT OR FUTURE BENEFITS APPLICABLE TO FEDERAL LOANS. CLICK HERE FOR MORE INFORMATION.
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Types of promissory notes

There are several types of promissory notes. Usually, the nature of the loan determines the appropriate type. Let’s take a closer look at some of the most common varieties.

1. Line of credit promissory note

Borrowers can withdraw any portion of funds from a line of credit up to the established maximum loan amount. Once the money is taken out, the borrower is liable for repaying the lender. A promissory note can be used to guarantee that the borrower repays money withdrawn from the line of credit. The promissory note can determine the interest rate, repayment schedule, and if the line of credit is secured or unsecured.

According to the 2020 Small Business Credit Survey from Federal Reserve Banks, business lines of credit and home equity lines of credit had approval rates of 79% and 69%, respectively. While a promissory note may be used by these traditional lenders, they are also an option for creating a line of credit from other sources.

2. Investment promissory note

Businesses looking to access capital can sell promissory notes to investors instead of taking out a conventional business loan or a line of credit. Through an investment promissory note, businesses receive capital from investors in exchange for fixed repayments. In the event a business is unable to repay, the investors may acquire the company.

Generally, investment promissory notes are sold at a discount to account for the impact of inflation on future payments. Promissory notes may be sold publicly in some cases but are most often purchased by corporate entities and experienced investors with high net worth who can handle the greater level of risk.

Businesses must be licensed to sell investment promissory notes, which must be registered with the Securities and Exchange Commission. Investors can verify promissory notes at the SEC’s EDGAR database.

3. Real estate promissory note

Promissory notes can be used in mortgages and other real estate purchases. In practice, borrowers use a home or other property as collateral for a real estate promissory note. While promissory notes can accompany a mortgage, they are in fact different. The note provides legal documentation of the borrower’s promise to pay, whereas the mortgage outlines the lender’s recourse for foreclosure if the borrower cannot repay the loan. A mortgage may also require a loan contract and more detailed financial information to qualify.

Real estate promissory notes can be used outside a mortgage. For example, two individuals could create such an agreement. Although the lender may not have the power of foreclosure, they can secure the agreement with the authority to place a lien on the property if a borrower defaults. A property lien creates a public record of a borrower’s unpaid debt.

Keep in mind that real estate promissory notes can be traded through brokerages without the borrower’s consent.

4. Student loan promissory note

College students will likely be required to sign a promissory note for both private and federal student loans. For private lenders, each student loan may carry its own promissory note since terms can vary. Anyone taking out federal student loans must sign a master promissory note to promise repayment of loans, fees and interest to the U.S. Department of Education. The MPN can cover multiple loans within a 10-year time frame for authorized schools.

How to shop for a car loan

Tips for shopping for a car loan — Auto loan financing can make purchasing a new or used vehicle affordable. But to find the best financing options, it’s important to know how to shop for a car loan. Car loan shopping requires some preparation and an investment of time. But fortunately, it’s relatively easy to shop for car loans and even apply for auto loan financing online.

Here are some tips that can make finding a loan to buy your car easier.

**Related: Smarter ways to get a car loan**

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1. Set your budget first — Before you get started shopping for auto loans, it’s important to know how much you can afford to pay for a vehicle. There are several things to factor into the equation, including:

Your target purchase price

How much you plan to offer as a down payment

Additional costs that may be due at signing, such as taxes, title fees, and dealer fees

Ongoing car insurance costs

Annual vehicle registration fees

Ongoing maintenance and repairs

If you have a vehicle you plan to trade in, you’ll also want to consider how that might affect the amount you’ll finance. The more trade-in value you can get for your current vehicle and the larger your down payment, the less you may have to finance.

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2. Check your credit before car loan shopping — If you apply for vehicle financing, potential lenders will check your credit report and scores as part of the approval process. Your credit scores can also influence the interest rate and annual percentage rate (APR) you’ll pay on an auto loan. That’s why that before you start shopping for a car loan, it’s important to understand how you might look to a potential lender based on your credit history.

Reviewing your credit reports and credit scores can provide you with some perspective on what kind of loan terms you’re likely to qualify for. You can get a free copy of your credit reports from each of the three credit bureaus (Equifax, Experian and TransUnion) through AnnualCreditReport.com. As you review your credit reports, look for the following:

Positive items, such as a solid payment history, that are helping your score

Negative items, such as payment delinquencies or maxed-out credit cards, that might be hurting your score

Errors or inaccuracies

If you spot any error or inaccuracy on your credit reports, you can dispute that information with the credit bureau that’s providing it. All three major credit bureaus allow you to file disputes online. Federal law requires them to investigate disputes and correct errors if they exist.

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3. Consider whether you'll need a cosigner — If your credit history is insufficient or you have a poor credit score because of past financial mistakes, getting a car loan could prove more difficult. In those scenarios, you might consider asking a cosigner to help you get approved for a loan. A cosigner can be a parent, a sibling, a friend or another creditworthy person who agrees to apply for auto financing with you. If you’re approved, you and your cosigner are treated equally in terms of responsibility for repaying the loan.

Asking someone to cosign has both pros and cons. On the pro side, a cosigner with an excellent credit score could help you get approved for vehicle financing at the best interest rates. The con, however, is that if you fail to repay the loan, you could ruin your credit and your cosigner’s, as well as your relationship. So it’s important to discuss the benefits and potential downsides with your prospective cosigner before asking for a commitment.

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4. Shop for car loans from multiple sources — Once you’ve checked your credit and have an idea of what loan terms you’re likely to qualify for, the next step is to compare loans from different lenders.

You have several options for where to shop for auto loan financing:

Brick-and-mortar banks or credit unions

Online banks and credit unions

Online lenders that provide auto financing

Dealership financing

Your current bank may be the first place you shop for car loans. If you’ve been a good customer for years or you have multiple accounts, your bank might be willing to offer an interest rate discount or other special incentives for getting a car loan. But don’t limit your search for a car loan to just your bank.

Take some time to compare interest rates and loan terms from online banks and credit unions, as well as online lenders that offer vehicle loans. If you’re buying a vehicle from a dealer, you can also ask about the dealer’s in-house financing terms.

What to look at when you’re comparing car loans — As you shop for a car loan, take note of the differences in what’s offered by different financing options. Specifically, pay attention to:

Interest rates

Annual percentage rates (APRs)

Loan repayment terms

Loan fees, including origination fees and/or prepayment penalties

Costs due at closing

Doing the math with an auto loan calculator can give you an idea of how much individual loans might cost you. It’s also helpful to check the reputation of any lender you’re considering as you shop for car loans.

Reading online reviews, checking the Consumer Financial Protection Bureau’s Complaint Database and looking at Better Business Bureau ratings can give you an idea of how trustworthy and consumer-friendly an auto lender may be.

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5. Consider getting prequalified or preapproved — Getting prequalified or preapproved for a car loan could be helpful when you’re narrowing down your financing options. Loan prequalification means that a potential lender has taken a look at your finances and is willing to lend you up to a certain amount of money.

Loan preapproval usually involves the added step of a hard credit check. If you’re interested in prequalification or preapproval, be prepared to share some basic information with your potential lender, including:

Your income

Your Social Security number (if a credit check is required)

Details about the vehicle you want to buy, including purchase price, age, make and model

Proof of auto insurance or the ability to be insured

You may also be asked about what kind of loan terms you prefer and how much money you plan to put down. Having a prequalification or preapproval in hand when you’re car loan shopping can give you a better idea of how much you can afford to spend and how much financing you’re likely eligible for.

Bringing a prequalification or preapproval letter to a dealer can also show that you’re serious about buying, which may make the dealer more willing to negotiate the purchase terms.

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6. Read the fine print before committing to an auto loan — As you shop for a car loan and choose your financing option, don’t neglect reading the fine print. It’s important to know exactly what your obligations are as a borrower and what your total borrowing costs add up to. When reviewing your auto loan documentation, be on the lookout for things like hidden fees or add-ons that you didn’t request.

If you spot anything in the loan contract that you don’t understand, don’t hesitate to ask the lender or financing company to explain it.

Also make sure you review the loan amortization schedule so you understand how much your loan will cost and how your payments will be applied over time. Your lender should provide this amortization schedule, which shows you how long it will take to pay off the loan and how much of each payment will be applied to interest, fees and the principal balance.

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The takeaway — Shopping around for the right car loan can take time. But it’s worth it to find the best option for your needs and budget. It’s also important if you want to get the best interest rates and loan terms available, based on your credit history.

When shopping for a car loan, you may want to consider whether a personal loan could be an appropriate choice for financing your vehicle. If you have a good credit score, it’s possible that you could qualify for an unsecured personal loan with a low fixed or variable APR. Whatever you choose, be sure to make your payments promptly in order to boost your credit rating and improve your chances of getting good loan rates on your next car.

**Learn more:**

**Pros & cons of car refinancing**

**Refinancing a car loan: What to consider**

*This article originally appeared on* *LanternCredit.comand was syndicated by* *MediaFeed.org*.

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5. Vehicle promissory note

A vehicle promissory note creates a binding document that promises a borrower will pay a lender for a car or other type of vehicle. This agreement can be between two individuals or a borrower and a conventional lender, such as a bank. Aside from repayment terms and conditions, it’s important to include the vehicle’s make, model, year, body and VIN in a promissory note.

6. Personal loan promissory note

It’s not uncommon to sign a promissory note when acquiring a personal loan from a traditional lender. A promissory note can also be used for a personal loan between friends and family. Formalizing the loan amount and repayment terms through a promissory note can help avoid disagreement and protect both parties down the line. Compared with typical personal loan requirements, a promissory note can be a more flexible financing option.

Having financial information like credit score and proof of income at the ready can streamline getting approved for a personal loan.

7. Promissory note repayment options

Besides type, promissory notes can differ by repayment method. Borrowers can expect to repay money and interest through one of the following options:

Lump-sum: This requires the entire amount to be repaid in a one-time payment on a specific date. Lump-sum payments are more common with small loans.
Due on demand: The borrower must repay the loan upon the lender’s request. Due-on-demand payment is used frequently for promissory notes between friends and family members. Any promissory note without written payment terms is considered due on demand.
Installment: Installment payments follow a specified schedule (monthly, for instance) to pay back a loan over a longer period of time. Usually, payments are structured as equal amounts and include interest.
With (or without) interest: A promissory note can define the interest rate and any related contingencies.

In some cases, a promissory note may employ a combination of repayment options. For example, a vehicle promissory note may include an upfront lump sum followed by installment payments.

What does a promissory note look like?

There are different laws in every state regarding promissory notes. One common feature of promissory notes is that they must be written. A verbal agreement between two parties will not qualify as a promissory note or carry the same legal enforceability. Promissory notes must also include language outlining an agreement and unconditional promise for the borrower to repay the loan. Additionally, the repayment must constitute money, rather than labor, professional services or other capital.

Other details and elements generally needed in a promissory note include the following:

Amount or principal: How much was borrowed and is to be repaid
Payor: The party promising to repay the debt
Payee: The party lending the money
Interest rate: States how much interest is charged and how it is calculated
Start date: The date the promissory note becomes effective and funding is released to the payor
Maturity date: When the interest and principal must be repaid in full

Without these elements, lenders may have trouble enforcing the promissory note.

The takeaway

Promissory notes create a binding promise to repay borrowed money. This financial agreement can be used when borrowing money from individuals and financial institutions.

Learn more:

This article originally appeared on SoFi.com and was syndicated by MediaFeed.org.

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