Oct 4, 2010

How to Write a Promissory Note

 


How To Write A Promissory Note: Charging Interest

There is no legal limit to the amount you can borrow, it can be anywhere from $1,000 or $1 million. However, there are guidelines about charging interest. The lender must charge an interest rate that reflects fair market value. This has to be at least the applicable federal rate, which is another of layer of scrutiny the IRS uses to determine if this is really a gift or a loan. You can find at list of rates at the IRS.gov. The AFR is adjusted monthly and currently ranges from around 0.7 percent on loans of three years or less to under 4.5 percent on loans longer than nine years.

Do a statewide search. States have usury laws for the highest rate of interest you can charge on personal loans, says Steingold. This was done to reign in predators and loan sharks. Check online or a law library for your state statues.

What type of credit risk is being taking on? That should also dictate how much interest is assessed, suggests Freeman. If you as the borrower are a good credit risk (you have the ability to pay and the assets to back it up) then the interest charged should be at the lower end of the spectrum and vice versa, Freeman explains.

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How To Write A Promissory Note: Pledging Security

The advantage of borrowing money is that you don't have to give up equity ownership in the business. You just have a financial obligation to pay your debt. However, sometimes a lender may want a security agreement, meaning that you are pledging or offering some type of collateral.

"If you are going to offer collateral than that needs to be listed on the note and the terms under which if you go into default what happens to the collateral to satisfy the obligation," says Freeman. "And it needs to also clearly spell out that if the collateral is liquidated for more than what is owed on the note then who get the excess."

Once you agree on the loan terms, be aware if you are signing on behalf of the business or yourself, says Freeman. "Are you personally liable for the loan versus signing it as a representative of your business entity whether it is a corporation or LLC?"

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How To Write A Promissory Note: Handling Missed Payments or Loan Default

You don't have to be an entity; any individual can garnish another person's business and personal bank accounts for failure to payback a loan. Once a borrower defaults and property or business assets are pledged, a lender can take legal action in terms of a lawsuit. The lender would go to court and get a judgment for attachment of property and force a sale to satisfy the debt. Seizing furniture or business equipment which can be sold to satisfy the debt is also recourse.

You have to be as specific as possible. "Sometimes a note will state that once a payment is missed then the loan is accelerated and the entire amount becomes due at that point," adds Freeman. Make sure there is a clause that says there is no prepayment penalty.

Above all, have the promissory note witnessed by a notary.

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