What Is a Loan Note?
Let me explain what a loan note really is—it's basically an extended version of a simple IOU document between two parties. As the borrower, you can receive payments from the lender, often with interest, over a fixed period, and it all wraps up when you repay the full loan on the specified date. These notes are typically issued instead of cash if you request it.
Think of a loan note as a contract that spells out the legal duties for both you as the borrower and the lender. A solid one will list penalties like the right to sue or go to arbitration if anyone defaults on their financial commitments.
Key Takeaways
- A loan note is a type of promissory agreement that outlines the legal obligations of the lender and the borrower.
- A loan note is a legally binding agreement that includes all the terms of the loan, such as the payment schedule, due date, principal amount, interest rate, and any prepayment penalties.
- Lenders typically require borrowers to agree to loan notes for big-ticket purchases, such as for a home or car.
- Loan notes can have tax benefits to the borrower and can also be a convenient source of seed money for new entrepreneurs and startups.
- In many cases, a loan note is preferable to an informal IOU because a loan note holds more legal significance and is easier to uphold in court should there be a disagreement between the parties.
How a Loan Note Works
A loan note is a form of promissory agreement that covers all the loan terms. It's legally binding, so both you and the lender are committed to what's written. Either party can draft it, but lenders usually handle it. The note stays valid until you've paid back the full amount as the borrower.
Important
Here's something key: a loan note can help you avoid a big tax hit from a lump-sum payment, like from a settlement or company cash-out.
Information Contained in a Loan Note
The loan note has all the essential details of the agreement between you and the other party. This includes names and contact info for both sides, the principal balance, and any interest rate over the loan term. You'll also find the payment schedule and due date.
It might include penalty details too, like what happens with late payments or prepayment fees.
Warning
Prepayment clauses protect the lender from losing interest income, but they mean you'll face a penalty as the borrower if you pay off the loan early, usually in the first few years.
Example of a Loan Note
Loan notes are common for installment debts where you're buying something like a good or service and paying over time. For instance, when you purchase a home, it comes with a loan note alongside the mortgage or deed of trust. They're also used for car financing and other installment loans.
Benefits of Loan Notes
As I mentioned, a loan note can shield you from heavy taxes on lump-sum payments from settlements or cash-outs. Between businesses, it lets the purchaser borrow and pay over time, often at low interest.
These notes are straightforward to create and convenient for both sides with basic details. They're often the first funding source for young businesses—startups and entrepreneurs use them to get seed capital from friends and family.
Special Considerations for Loan Notes
Legally, a loan note carries more weight than an informal IOU, even if the IOU is notarized. It generally holds up unless someone proves the agreement was made under duress, which could void the terms and make it unenforceable.
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