A non-interest-bearing promissory note involves either truly having 0% interest or else already including a flat fee or rate within the note's face value. Therefore, the principal amount and maturity amount of the promissory note are the same.
The promissory note is issued by the lender and is signed by the borrower (but not the lender). It is considered a contract, and signing it legally obligates the borrower to pay back the amount borrowed, plus any interest, as defined in the promissory note.
When the promissory note is discounted, the interest is taken off the principal amount at the beginning of the loan. The borrower pays back the entire amount, even though he only received the principal minus the interest.
Just as with some other types of contracts, there is a requirement for certain Notes that they be in writing and that requirement is located in the California Civil Code, 1624(a) which provides that certain contracts, “…are invalid unless the same, or some note or memorandum thereof, is in writing and subscribed by the ...
A promissory note could become invalid if: It isn't signed by both parties. The note violates laws. One party tries to change the terms of the agreement without notifying the other party.
The note must clearly mention only the promise of making the repayment and no other conditions. After issuance, a Promissory Note must be stamped according to the regulations of the Indian Stamp Act.
An unsecured promissory note is an obligation for payment without any property securing the payment. If the payor fails to pay, the payee must file a lawsuit and hope that the payor has sufficient assets that can be seized to satisfy the loan.
It's important to calculate interest on a note because that's how much you're committing to pay. Simple interest is computed by multiplying principal, rate, and time. Compound interest on promissory notes accrues by adding interest to the principal periodically.
There are three types of promissory notes: unsecured, secured and demand.
With Few Exceptions, You Need to Charge Interest
Unfortunately, the IRS may “impute” interest received to the seller, even if the parties agreed to zero interest or a rate below the IRS' published rates. As the saying goes, there's no such thing as a free lunch.
Notes may be referred to as interest bearing or non-interest bearing: Interest-bearing notes have a stated rate of interest that is payable in addition to the face value of the note. Notes that are zero-bearing or non-interest bearing do not have a stated rate of interest.
Scenario: Interest-free loans
For tax purposes, if you loan a significant amount of money to your kids — over $10,000 — you should consider charging interest as a lender. If you don't charge interest, the IRS can say the amount of interest you should have charged was a gift based on current tax rules.
The present value of the non-interest-bearing note is calculated by multiplying the present value factor with the future value of the note. The future value of the note means the face value of the note. r is the interest rate applicable on a similar note, and n refers to the period of the note.
A blank bill of exchange differs from a standard draft in that some of the particulars are not completed at the time of issue. However, this does not mean that any information can be missing – even a blank promissory note should contain the signatures of the issuer, the draftsman and any guarantors.
A non interest-bearing note does not have a stated interest rate applied to the face value of the note. Instead, the note is drawn for a maturity amount less a bank discount; the borrower receives the proceeds.
Every promissory note should specify the interest rate charged on the loan, regardless of the relationship between the parties. Interest rates are required because in the eyes of the Internal Revenue Service (the “IRS”), there is no such thing as a zero-interest loan.
Interest (“Interest”) shall accrue on the Principal amount of this Note at the rate of ten percent (10%) per annum (the “Interest Rate”), compounded monthly on the last day of each calendar month beginning on the Interest Effective Date (“Monthly Interest”).
A lender may charge an interest rate of up to 10% per annum if the rate is specified in the Promissory Note. And in certain instances, the applicable rate can be as high as 18% per annum. Certain creditors are completely prohibited from charging a rate higher than 10%.
Some common triggers that can invalidate and cause problems in a promissory note are: missing the payment schedule or interest rate, loss of the original copy of the document, and others. When a promissory note becomes invalid the lender cannot sue the borrower legally if they fail to make payments.
Borrowers sometimes think that including collateral is optional for promissory notes. While collateral isn't mandatory in unsecured notes, it's a critical component of secured notes. Failure to differentiate between these two can affect the borrower's financial risk and interest rate.
Next, you might seek out potential buyers, which could include private investors, debt buying companies, or financial institutions. Marketing your note effectively, perhaps through unsecured promissory note brokers who specialize in such financial instruments, can help find interested parties.
I REPEAT: Both parties must sign the promissory note! This means both the lender and borrower must sign the original document (plus any amended versions). Without the signatures, the promissory note has no legal leg to stand on.
Key takeaways
A loan agreement is a contract between a borrower and a lender that specifies what each party has agreed to. A promissory note is where one party promises, in writing, to pay a set amount to the other according to their agreement.
Bank Method: "The annual interest rate for this Note is computed on a 365/360 basis; that is, by applying the ratio of the annual interest rate over a year of 360 days, multiplied by the outstanding principal balance, multiplied by the actual number of days the principal is outstanding."