Loan Agreement vs. Promissory Note: Key Differences Explained

Loan Agreement vs. Promissory Note: Key Differences Explained

Both promissory notes and loan agreements are legally binding documents that record a lending transaction. But they're different tools for different situations, and choosing the wrong one — or nothing at all — can create real problems when repayment goes sideways.

What Is a Promissory Note?

A promissory note is a one-sided, written promise by the borrower to repay a specific amount of money to the lender under defined terms. it's signed only by the borrower.

Key features: - Signed by the borrower only (can be signed by lender for acknowledgment, but not required) - Simpler document — typically 1–2 pages - States the principal amount, interest rate, repayment terms, and consequences of default - Can be "demand" (repayable at any time) or installment (fixed payment schedule) - Negotiable — can be sold or assigned to a third party

A promissory note is the borrower saying: "I promise to repay $5,000 plus 6% annual interest in 12 monthly installments of $430."

What Is a Loan Agreement?

A loan agreement (also called a credit agreement or financing agreement) is a more comprehensive bilateral contract, signed by both parties, governing an entire lending relationship. It typically covers:

• Purpose of the loan
• Disbursement terms (when and how funds are released)
• Repayment schedule
• Interest rate and calculation method
• Default and cure periods
• Remedies for default (acceleration of the full balance, collateral seizure)
• Representations and warranties by the borrower
• Covenants (ongoing obligations during the loan term)
• Governing law

Loan agreements are more common in commercial/business lending contexts.

When to Use a Promissory Note

Use a promissory note for: - Personal loans between friends or family - Simple short-term loans where both parties understand the terms - Student loan documentation - Documenting an informal IOU in legally binding form - Seller financing in a real estate or business transaction

When to Use a Loan Agreement

Use a loan agreement when: - Significant amounts of money are involved ($10,000+) - The loan involves complex terms with conditions or covenants - There is collateral securing the loan - The loan is to a business rather than an individual - Multiple advances will be made over time (revolving line of credit) - You need detailed provisions about events of default and remedies

The Overlap

In practice, these terms are sometimes used interchangeably, and some documents labeled "promissory note" include terms comprehensive enough to constitute a loan agreement. What matters is not the label but the content — make sure the document you sign covers all the key terms.

What Both Documents Must Include

Regardless of which you use: 1. Names and addresses of lender and borrower 2. Loan amount (principal) 3. Interest rate (or 0% if no interest) 4. Repayment terms — amount, frequency, final due date 5. What constitutes default 6. Late payment penalties 7. Governing state law

Lending to Friends and Family

Loans to friends and family are where the most informal arrangements go wrong. Even if it feels awkward, create a written document. If you don't, and the borrower doesn't repay: - You have no legal basis for a collection lawsuit - The IRS may treat the money as a gift (which has gift tax implications for large amounts) - The relationship suffers doubly — from the money AND from the legal ambiguity

Create a simple promissory note with iRunDocs — and protect both your money and your relationship with clear, written terms.