Promissory Note vs. Loan Agreement: Key Differences Explained

Difference Between a Promissory Note & a Loan Agreement

A promissory note and a loan agreement both commit you to pay back a sum of money by a certain date at a specific interest rate. The big difference is size: A loan agreement is longer and covers much more ground.

The Promissory Note

A promissory note is a written promise to pay someone money. If someone makes you a loan, signing a promissory note gives you a legal obligation to pay it back. An IOU saying, "I owe John Smith $1,000" doesn't qualify; a promissory note has specifics:

• The amount of the loan
  
• The interest rate
  
• The maturity date
  
• Any late fees or penalties

A promissory note can direct you to pay someone other than the lender. For example, if you borrow money from a friend, the note can direct you to "pay to the order of" someone else, such as her spouse or child.

The Loan Agreement

A loan agreement serves the same purpose as a promissory note. It covers the terms for repaying the loan and identifies the debtor and creditor. However, it goes into much more detail about the legal rights and obligations of both parties.

Unlike a promissory note, both you and the lender must sign the agreement. This difference can be significant. A promissory note doesn't commit the lender to anything. A loan agreement imposes obligations on both parties.

Laws That Apply

Loan agreements and promissory notes both have to conform to state and federal law to be legal. Both documents are a type of contract, so they must follow contract law. A promissory note can be written to be a negotiable instrument: The lender can transfer the note, and the right to receive payments, to someone else. If the note is negotiable, it must conform to the laws covering negotiable instruments as well as contracts.