Understanding Promissory Notes: What They Are and Why They Matter

If you're among the 83% of Americans who carry some form of debt — like a mortgage, auto loan, credit card balance, medical bill, or student loan — there's a good chance you've signed a promissory note. It's the document that outlines your promise to repay what you borrowed.

This guide breaks down what a promissory note is, how it works, the different types you might encounter, and how to create one if needed.

What is a promissory note?

A promissory note is a legal document that outlines a borrower's written promise to repay a loan. While similar to a loan agreement, a promissory note is usually simpler. It focuses on your repayment obligation as a borrower. In contrast, a loan agreement typically includes more detailed terms — like interest rates, payment schedules, and what happens if you default on the loan. A promissory note must generally be signed before loan funds are released.

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How does a promissory note work?

Lenders and borrowers can use promissory notes to ensure both parties are on the same page. When taking out a loan, a promissory note includes pertinent information about the agreement between the lender and the borrower. Generally, a promissory note may include the following details:

• Principal loan amount
• Interest rate, if applicable
• Payment schedule
• Promise to repay the loan
• Borrower's signature

The rules surrounding promissory notes vary from state to state. Depending on where you live, the details included in a promissory note can look a little different.

Types of promissory notes

Promissory notes come in different styles, typically secured or unsecured promissory notes:

• Secured promissory notes: These agreements include collateral to secure the loan. For example, a mortgage promissory note is secured by a physical home, and an auto loan promissory note is secured by a vehicle. If the borrower doesn't uphold the terms of the promissory note, the lender can seize the collateral as compensation.
• Unsecured promissory notes: These agreements don't include assets as collateral. For example, some personal loans and student loans come with an unsecured promissory note. Due to the lack of collateral, unsecured promissory notes tend to come with more risk for the lender.

Is a promissory note legally binding?

“A promissory note is legally binding when it meets the essential contract elements: offer, acceptance, consideration, capacity, and lawful purpose,” says Chad Cummings, certified public accountant (CPA) and attorney at Cummings & Cummings Law.

Since different states can impose different requirements on promissory notes, you'll need to review the exact requirements for your state to confirm that the document is legally binding.

With a legally binding document in hand, both borrowers and lenders benefit. The document clearly outlines the borrower's obligation, which means the borrower cannot accidentally underpay, and the lender cannot expect overpayment beyond the note's terms.

If a borrower defaults on the loan, a promissory note gives the lender the legal right to attempt recouping the loss through other means. For example, this document might give the lender the legal right to seize a collateral asset or sue the borrower for the unpaid loan balance.

How to create a promissory note

“People can draft promissory notes on their own,” says Travis Christiansen, attorney at Boyack Christiansen Legal Solutions “But because every state has different requirements to ensure it would be a binding legal agreement, it may be wise to hire an attorney to ensure all the required elements are included,” he advises.

Christiansen adds that the real issue often isn't how the contract is written, it's what happens if one party fails to follow through. In those cases, having a properly drafted document can make the difference in whether or not a court enforces it.

If you decide to write your own promissory note, make sure to include:

• Names and addresses of borrower and lender
• Loan amount
• Interest rate, if applicable
• Payment schedule, if applicable
• Possible penalties
• Signatures from both parties

Keep in mind that even attorney-drafted notes can be challenged. “If one party disputes the validity, a court would be the ultimate deciding factor on if the contract was valid,” says Christiansen.