PROMISSORY NOTE
VERSUS LOAN AGREEMENT

 

Loaning or borrowing money always comes with some risk. To help reduce the risk, it is smart to have written documentation in place. There are two main types of contracts people use when loaning money in Arizona. Each is suitable for different situations, so it is important to know the differences and work with an experienced attorney to ensure you are using the right one for your needs.

What is a Promissory Note in Arizona?

A promissory note is a legal contract that sets out the terms for one party borrowing money from another party. It is a one-sided contract. This means that it only sets obligations for the borrower. It does not bind the lender and only has to be signed by the borrower.

What Terms are Include in a Promissory Note?

Standard terms that are included in Arizona promissory notes include:

• The amount of money borrowed (also known as the principal);
• The interest rate;
• The repayment date (this can be either a fixed future time or on demand of the lender); and
• Any late fees or penalties in the event of default.

When Should You Use a Promissory Note in Arizona?

Promissory notes are less detailed than loan agreements and typically used for smaller sums of money and shorter terms. They are a good choice if you are lending money to family and friends where there is a level of trust between the parties. Promissory notes are perfect for the times where a more complex document is not necessary, but you still want a clear record to minimize confusion or misunderstanding when loaning money. For example, one scenario where it would make sense to use a promissory note would be to lend money to a family member for their wedding.

What is a Loan Agreement in Arizona?

Like a promissory note, a loan agreement is a legal contract that sets the terms for a party borrowing money from another party. It is usually more detailed and complex than a promissory note and places obligations on both the borrower and the lender. However, the lender typically isn’t binding themselves to any action. Rather, the lender is acknowledging the rights and options for non-payment. Both parties must sign the loan agreement.

There are two main types of loan agreements—secured and unsecured. In a secured loan, if the borrower fails to repay the loan, the lender can take ownership of the borrower’s assets that were security. Common personal assets that are used as collateral to secure a loan include homes and cars. An unsecured loan is not guaranteed by any collateral. If the borrower fails to repay the unsecured loan, there is limited recourse available. Examples of unsecured loans include credit cards and student loans.

What Terms Are Included in a Loan Agreement?

Loan agreements are typically much more detailed than promissory notes. Standard terms included in Arizona loan agreement include:

• The loan amount (“principal”).
• The interest rate.
• The repayment schedule. Usually, payments are due over a fixed term and schedule.
• The consequences of default. Default refers to a failure to repay or meet any other obligation under the loan agreement. Some consequences of defaulting include collateral repossession, immediate repayment of the loan, and additional interest due.
• Representations and warranties. Representations and warranties are factual statements relating to past or present circumstances that the lender relies upon. The lender will want to understand the amount of risk that they are taking and the probability that the borrower will be able to pay back the loan. The parties are legally responsible for the truthfulness of the information provided. For example, the borrower could make a representation that they own the property that is being offered as collateral or include a warranty that they will use the money received from the lender on the items specified in the loan agreement.

When Should You Use a Loan Agreement in Arizona?

Loan agreements are more formal contracts than promissory notes. They are used for larger and more complicated loans, especially where there isn’t a level of trust between the parties. Vehicles, homes, and business ventures are all examples of lending where a loan agreement would be used in Arizona.

Your Phoenix Attorney

A local business planning attorney can help you decide which agreement is best for you and your situation. Nicole Pavlik has years of experience assisting Arizona residents draft promissory notes and loan agreements. Call Nicole Pavlik Law Firm today at 602-635-6176 for a free consultation.