The Difference Between A Promissory Note And A Loan Agreement

Whether you’re lending money, or borrowing money – it’s a significant commitment.

If you’re the borrower, you’re likely concerned about aspects such as the repayment date and securing a fair interest rate.

If you’re the lender, you’re understandably anxious about recovering your money, along with considerations like the interest rate and timing.

As with many legal matters, one of the most crucial steps is getting your agreement in writing.

Having a written contract can achieve the following:

1. Facilitate a mutual understanding of a fair deal.
2. Provide certainty regarding the terms agreed upon.
3. Offer a legal remedy if either party fails to fulfil their obligations.

Opting for a contract seems like a straightforward choice! But one question remains: What type of contract?

When it comes to lending and borrowing money, there are 2 principal types of contracts: loan agreements and promissory notes.

To assist in determining which is best for you, let’s explore the differences between a promissory note and a loan agreement.

What Is A Promissory Note?

A promissory note is a binding document. It outlines the terms under which one party borrows money from another.

A promissory note can be relatively straightforward to use, as it is typically quite simple.

For starters, a promissory note only needs to be signed by the borrower. This is because it solely details the borrower’s obligations to repay the lender – the lender has no specified obligations.

A promissory note will generally specify details such as:

• The sum of money borrowed
• The interest rate
• The repayment date
• Any late fees or penalties

Promissory Note Example

Promissory notes are often utilised for smaller amounts of money. They can be a suitable option when lending to friends or family – it’s always preferable to have a written agreement than none at all.

For instance, if your sibling’s business needs to borrow $2,000 to purchase office furniture and they prefer not to enter into lengthy agreements, a promissory note might be suitable.

In any scenario where you’re considering lending or borrowing money – and documenting it – you should seek professional legal advice.

How To Write A Promissory Note

Although it’s a straightforward document, it’s advisable to have a professional assist you in drafting a promissory note. Clarity is essential.

Beyond your financial risks, there are significant legal risks associated with an incorrectly drafted promissory note. In particular, various financial regulations may apply depending on its structure.

What Is A Loan Agreement?

Now that we understand promissory notes – what about loan agreements?

A loan agreement is also a legal document that sets out the terms under which one party borrows money from another.

The key distinctions between a loan agreement and a promissory note are:

• Loan agreements are typically more comprehensive and intricate
• Loan agreements impose obligations on both the borrower and lender (thus requiring signatures from both parties)

Given that loan agreements impose duties on both parties and include more provisions, they provide greater legal security for everyone involved.

In essence, a loan agreement reassures both parties that the lender will provide the agreed sum of money, and the borrower will repay it.

What’s Security?

To add another layer of complexity, there are 2 main types of loan agreements: Secured or unsecured.

• Secured loan: if the borrower defaults on the loan, the lender can claim ownership of a valuable asset, such as property. This asset is taken as ‘security’ for the loan. For a secured loan, a separate ‘security agreement’ may also be necessary. The secured asset will typically be registered on the Personal Property Securities Register (PPSR) in New Zealand.
• Unsecured loan: There is no collateral for the loan. If the borrower fails to repay, the lender has limited options to recover the funds.

How To Write A Loan Agreement

As a loan agreement is a complex and significant legal document, it’s wise to have a solicitor draft it for you.

A loan agreement will typically address aspects such as:

• The loan amount
• The interest rate
• The repayment schedule
• Consequences of loan default
• Warranties and other commitments

A solicitor can also provide guidance on the legal options available and the types of protections you can seek as either the lender or the borrower.

What to take away…

Securing a loan for your next business endeavour could provide the financial support you need, and documenting the loan terms in a promissory note or loan agreement is a prudent decision.

If you’re considering a promissory note or loan agreement, it can be challenging to determine which is best for your needs and what to include. Investing in legal assistance for this process is a one-time expense that can prevent misunderstandings and disputes in the future.

Please feel free to contact us for a no-obligation discussion on how we can assist you in drafting a loan agreement or promissory note, as well as with any other legal matters your business may face. Call us on 0800 002 184.

---