Understanding how the documents are similar and different assists as you navigate the loan process.
- Your loan might come with a loan agreement or promissory note
- Promissory notes are typically more informal
- Loan agreements are more complex documents that outline specific terms
- Your mortgage will likely have a loan agreement because of the amount of money involved
You might feel like you're signing your life away upon entering a mortgage or other loan agreement because so much paperwork requires your attention. Each document has a specific purpose as you secure your loan, ensuring you and the lender are legally bound by its terms.
In some situations, you might hear the words loan agreement and promissory note mentioned by the lender or other professionals as you navigate the loan process. These documents have similarities because they state you'll repay the money you're borrowing, but they are ultimately different.
Learning about these two documents is essential to understanding what you're getting into with your loan. What is the difference between a loan and promissory note? Here's a look at both documents and their similarities and differences.
What is a loan agreement?
Put simply, a loan agreement is a formal contract you'll enter with a lender when you borrow money. It typically appears as part of a mortgage, but banks and other institutional lenders will use these documents when you borrow a large amount of money for any purpose.
A loan agreement is typically a multi-page document that covers the loan's terms, how the payment process will work, what will happen if you don't repay the money, and other contractual items. Your loan agreement paperwork will likely be lengthy and rigid, so it's best to have a professional look it over before signing anything.
What is a promissory note?
Like a loan agreement, a promissory note is legally binding. It's issued by the lender to the borrower and outlines the repayment terms the borrower must meet over the course of the loan.
A promissory note is usually shorter and less formal than a loan agreement, as it only outlines the repayment terms while ignoring many specific contractual terms. You'll likely issue a promissory note to a borrower if you lend money to a family member or investor for real estate purposes.
The promissory note you present should include the loan amount, the interest rate, the maturity date, and any late fees or penalties. It can also direct you to pay someone other than the original lender, such as a partner.
How the documents are similar
If these closing documents sound similar, it's because they are in many ways. First, both agreements describe the amount of money the borrower will have to repay to fulfill the loan terms. Since both items are legally binding when properly used, the borrower must pay the lender back, no matter the documentation.
Both documents often cover the consequences of non-payment. The exact terms depend on the loan type and amount of money, but each document should clearly delineate the lender's recourse if the borrower defaults on the payments.
Loan agreements and promissory notes both legally bind the borrower to the consequences of non-payment outlined in the document. The person receiving the loan will have to sign the document before completing the process and receiving the money.
The difference between a loan and promissory note
As you dig deeper into the concept of loan vs. promissory note, you'll see the documents have some significant differences. As a borrower, you should have a loan agreement because of the additional protections it provides.
The reason is that a promissory note doesn't bind the lender in any way. Only the borrower signs this note, so there aren't any legal protections in place for borrowers if lenders don't follow through on their half of the agreement. So, there's no obligation for the lender to do anything when there's only a promissory note, which could be a significant difference in some scenarios.
Another difference is the complexity of the documents. Loan agreements are typically much more extensive and have much more information to cover. For example, a mortgage has some very specific terms to address before it becomes official, meaning a mortgage loan agreement will be very long.
Financial institutions want to protect themselves from any scenario that could arise. They have attorneys continuously revise their loan agreement documents until they're as iron-clad as possible. Any loan document you receive from a bank will contain multiple pages of complex language to ensure the institution gets its money back or that you face the consequences for defaulting on your mortgage.
Finally, a promissory note is usually more informal than a loan agreement. While this isn't always the case, you'll usually see promissory notes when borrowing money from friends or family or for a short-term loan for a small amount of money.
Loan agreements are typically used for mortgages, car loans, and business loans, so there's more money involved. In this scenario, you won't get away with a less formal document because the financial institution you're using will have a specific loan document for your situation, and it will probably be complex.
Get the mortgage help you need
Because loan agreements can be so complex, you will benefit from professional assistance as you review yours. This consultation is particularly vital when finalizing a mortgage because of the amount of money the loan will involve or when lending money to family or investors for real estate purposes. Fortunately, an attorney can provide the insight you need to review these documents when buying real estate or lending money.
PeytonBolin provides real estate legal assistance in South Florida. Our team offers legal consultations, so borrowers understand their obligations when receiving a loan. We also have a private lender document preparation service, supplying you with a promissory note for the borrower to sign when lending money. Contact PeytonBolin for more information on our legal services in the real estate industry.