An Unsecured Promissory Note is a document used by lenders to detail the borrowing of money by an individual or an entity to be reimbursed with interest (if any) without security.
Unlike a promissory note, the lender’s transaction with the borrower is based on trust and their willingness to repay the debt without receiving any collateral or security in return (usual borrowers with high credit scores). Payments in such cases are usually structured on a weekly, bi-weekly, or monthly basis with installments scheduled for specific dates and without any prepayment penalties.
Just like a secured promissory notes’ fine-print terms and conditions, an unsecured promissory note details the following information:
- The borrower’s promise to repay the loan
- The amount lent and the corresponding interest rate
- The frequency of payments and to whom such payments are to be made
- The amount to be repaid in each installment
- Any additional fees
- The terms for late payments and what will happen when they fail to repay the loan
Unsecured vs Secured Promissory Note
Both the lender and the borrower should understand the difference between an unsecured promissory note and a secured promissory note. In as much as they may look the same and have almost the same elements, there is one key difference between the two.
An unsecured promissory note is a document stating that the borrower “promises” to repay the amount due. There is no security/collateral for the lender if the borrower fails to repay the loan.
On the other hand,
A secured loan has a form of security or collateral in place in case the borrower fails to fully repay their loan as agreed.
The collateral can be in the form of a car, house, financial accounts, or other related assets. Regardless of the item included as collateral or security, the secured promissory note outlines what it is and provides that the lender can collect the specified assets when the borrower defaults on their payment. The security/collateral provided provides the lender with some degree of assurance when issuing the loan, especially in huge loan amounts.
Components of Unsecured Promissory Note
There are three main components of any unsecured promissory note. They include:
Repayment type
This is one of the most important components of any promissory note- i.e., how the money shall be repaid. There are different ways in which the lender may choose to be repaid, including through:
- Installments– This is the commonly used repayment method used by most lenders. Installment payment gives the lender a clear view of how the borrower is making good on their word. If there is an issue, the lender may be able to know if there are any missed payments.
- Interest-only payments: This payment option is usually used when the borrower and the lender are well acquainted or have a good reputation and/or good credit score. The borrower using this mode of repayment only makes payments on the loan’s interest until the due date, in which they will then have to repay the entire loan amount.
- Lump-sum: This method is used if the borrower is not required to pay interest on the loan or make installment payments.
Fees and default
Despite being unsecured, unsecured promissory notes usually have repercussions if the borrower misses a payment or fails to comply with the specified terms and conditions in any way. Such repercussions include:
- Interest Fees- The borrower is given a time limit, usually 15 days, to correct their default before they are charged interest on the amount due
- Late Fee- The lender sets a day count after the repayment date is due. If the lender fails to repay the amount within the set days, the lender can charge them a late fee, usually determined by the amount in question.
Conclude agreement
Go through the document, make sure that it is free of any grammatical errors, and that it does not exceed three pages. Before signing, make sure that the borrower goes through the document and is conversant with its terms and conditions.
Making an Unsecured Promissory Note
Since unsecured promissory notes do not have any collateral, should the borrower default on their payment, the lender may have no option but to seek restitution through small claims court or other legal proceedings if the loan is a large sum. It is important, therefore, to know how to properly craft an unsecured promissory note, as the document may come in handy in the event of a default or other litigations. The note also allows the lender to charge a higher interest rate and profit on their money.
Here is how to properly write an unsecured promissory note:
Provide information
- Enter the date the document was executed
- Enter the borrower’s name as is in their identification document
- Enter the borrower’s official address, i.e., city, state, zip code
- Enter the name of the lender and the lender’s address
- Submit the principal sum of the note
- Enter the percentage/interest accruing annually
Payments
- Method of payment- make sure to confirm with the borrower their preferred method of payment to include when preparing the document.
- No Installments- if the amount is to be repaid in full without any installments, make sure to mention it in the document.
- Installments- enter the exact amount, including the interest and the principal.
- Interest-only payments- if the selection is either installments or interest-only payments, make sure to specify in the document
- Schedule of payments- select whether the payments shall be paid monthly or weekly. If they are to be paid on a:
- Monthly basis- enter the day/date of each month the payments should be made
- Monthly basis- enter the day/date of each month the payments should be made
- Due date- enter the due date for when the payments, including accrued interests, late fees (if any), should be paid.
- Interest due in the event of default- enter the percentage per annum or the exact amount of interest due should the borrower default on their payments.
- Titled Sections- Create a titled section to include any other additional information that will aid the transaction such as:
- Allocation of payments
- Prepayment
- Late fees- include the exact number of days in which the borrower must repay their loan to avoid incurring late fees
- Acceleration- provide the exact number of days the borrower will have to sure the default resulting from late payments
- Attorney fees and costs- mention if the borrower will cater for the attorney fees and any extra costs should the case proceed to court
- Waiver of presentments
- No-waiver
- Severability
- Integration- mention any verbal or other agreements, if any, that modify or affect the terms of the note and how either party may amend the note.
- Notice
- Execution
- Signatures- the document will have to be signed in the presence of at least two witnesses.
Include:- The date of signing the document
- The lenders signature
- The lenders print name
- The borrower’s signature
- The borrower’s print name
- Witnesses’ names and their respective signatures
Forms by State
Here are free forms for each state:
Frequently Asked Questions (FAQs)
Yes, one can enforce an unsecured promissory note as long as it is fully completed, i.e., all the information required is duly filled, including the borrower and lender’s information.
Promissory notes are legally binding. If the borrower fails to repay the loan as agreed upon in the agreement, they may lose their assets, be taken to small claims court, be liable to pay attorney fees or pay other fees incurred in the process.
