The Difference Between A Promissory Note And A Loan Agreement

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

If you’re the borrower, you’re probably worried about things like the repayment date and getting an unrealistic interest rate.

If you’re the lender, you’re probably worried about getting your money back! Along with things like the interest rate and timing too.

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

Having a written contract can do the followings.

Get the parties to agree on a good deal.
Provide certainty about what was agreed.
Provide a legal solution if either party doesn’t carry out their obligations.

Getting a contract sounds like an easy decision! Except for one question: What kind of contract?

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

To help decide which is best for you, let’s look at the difference between a promissory note and a loan agreement.

What Is A Promissory Note?

A promissory note is a legal contract. It sets out the terms for one party borrowing money from another party.

A promissory note can be quite easy to use, because it is usually very simple.

For starters, a promissory note only has to be signed by 1 party: the borrower. This is because it only sets out the obligations of the borrower to repay the lender – there are no obligations on the lender.

A promissory note will typically specify things like:

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

Promissory Note Example

Promissory notes are normally used for smaller sums of money. They can be a good option if you’re lending money to friends or family – it’s always better to have something in writing than nothing.

For example, if your sibling’s business needs to borrow $2000 to buy some furniture for their new office and they don’t want to sign any long agreements, a promissory note may be an option.

In all situations where you’re thinking of lending or borrowing money – and documenting it – you should seek professional advice.

How To Write A Promissory Note

Even though it’s a simple document, it’s best to get a professional to help you put together a promissory note. It’s not something you want to be confused about.

Aside from your own financial risks, there are also some big legal risks to getting a promissory note wrong. In particular, different financial regulations could apply depending on how it’s drafted.

What Is A Loan Agreement?

Now we know about promissory notes – what are loan agreements?

A loan agreement is also a legal contract that sets out the terms for one party borrowing money from another party.

The main differences between a loan agreement and a promissory note are:

Loan agreements are normally much more detailed and complex
Loan agreements place obligations on both the borrower and lender (which means it needs to be signed by both parties)

Since loan agreements put obligations on both parties and contain more clauses, they offer more legal protection for both sides.

In the simplest sense, a loan agreement provides both parties with reassurance that the lender will loan the agreed amount of money, and the borrower will repay it.

What’s Security?

So, to complicate things more, there are 2 main types of loan agreements: Secured or unsecured.

Secured loan: if the borrower fails to repay the loan, the lender can take ownership of a valuable asset, such as a house. In other words, the house is taken as ‘security’ for the loan. If you get a secured loan, you may also need a separate ‘security’ agreement. The secured property will usually be registered on the Personal Property Securities Register, also known as the PPSR.
Unsecured loan: There is no security for the loan. If the borrower fails to repay the loan, there is limited recourse for the lender to recover the loan money.

How To Write A Loan Agreement

Again, as a loan agreement is a complex and important legal document, it’s best to get a lawyer to draft it for you.

Generally, a loan agreement will cover things like:

The loan amount
The interest rate
The repayment date
What happens if the borrower defaults on the loan
Warranties and other covenants

A lawyer can also help advise you on what legal options are available and the types of protections you can seek as either the lender or the borrower.

What to take away…

Taking out a loan for your next business venture can be just the financial boost you need, and documenting the terms of the loan in a promissory note or loan agreement is a smart choice.

If you’re after a promissory note or loan agreement, it can be hard to know which is best for you and everything you need to include. It’s a good idea to invest in a lawyer to assist you with this process, as it’s a one-off cost that can save you from misunderstandings and disputes in the long run.

Feel free to get in contact with us for a no-obligation chat on how we can help you put together a loan agreement or promissory note and help with any other legal issues your business may have.

Minna Boyle

Minna is the Head of People & Culture at Sprintlaw. After completing a law degree and working in a top-tier firm, Minna moved to NewLaw and now manages the people operations across Sprintlaw.

Tomoyuki Hachigo

Tomo is the co-founder of Sprintlaw and a commercial lawyer with a broad range of legal experience. Before starting Sprintlaw, he was an M&A lawyer at a top-tier law firm advising businesses of all sizes from large corporates to startups.