What’s the beautiful thing about a promissory note? It’s a written “IOU” between a lender and borrower that’s legally binding. But in order for this type of loan agreement to stay legally binding, it needs to have certain elements—and avoid certain things too. 🙅🏽♀️
By crafting or managing a promissory note incorrectly, you could invalidate it, so let’s dive into the eight ways a promissory note can become invalid. Plus, we'll cover examples of what these errors look like. 🕵🏼♂️
What does a valid promissory note look like?
It looks a lot like an informal “IOU” letter but includes specific elements. You can use a valid promissory note for real estate mortgages, car loans, student loans, and even unsecured personal loans between friends and family members. It features reasonable terms and clear clauses.
This type of legally binding IOU depicts the amount of money owed, its due date, and who the borrower and lender are. Both parties sign it and the payee holds on to the original note. Any changes to the original incur a signed, amended version which otherwise may create a breach of contract.
What invalidates promissory notes?
Here are eight ways your promissory note can become invalid:
1. Incomplete signatures
Both parties must sign the promissory note. ✒️
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.
2. Missing payment amount or schedule
A promissory note can become invalid if it excludes A) the total sum of money the borrower owes the lender (aka the amount of the note) or B) the number of payments due and the date each increment is due.
The payment amount and schedule tell the court the basic terms of the loan agreement. 👩🏾⚖️
3. Missing interest rate
Don’t know what to charge or have other related questions? 🤔 Check out the IRS Applicable Federal Rates (AFRs) for family loans.
4. Lost original copy
The lender should keep the original copy of the written loan agreement. This is true even if the lender and borrower change the terms and sign off on the amended version.
Without an original copy, the involved parties may have trouble proving legitimacy.
5. Unclear clauses
If the clauses in your promissory note are unclear, the court may be unable to interpret it. If a court can’t interpret a loan agreement, it becomes invalid. *Not legal advice*
PRO TIP: You can avoid unclear clauses by using a promissory note template. Dealing with a personal loan between friends and family? Create a valid loan agreement yourself.
6. Unreasonable terms
U.S. law loves the term “reasonable.” 💌 Promissory notes are no different. Unreasonable terms can invalidate a promissory note.
The court determines what’s unreasonable, so there’s no hard and fast rule. You can avoid it by charging market rate interest and giving the borrower enough time to make a repayment.
7. Past the statute of limitations
Promissory notes have a statute of limitations. Depending on which U.S. state you live in, a written loan agreement may expire 3–15 years after creation.
For example, Florida’s statute of limitations on promissory notes is five years.
8. Changes made without a new agreement
What if the lender or borrower makes changes to the promissory note? In this case, both parties must sign off on an amended version.
Fun fact: You can make official amendments to personal loan agreements with the help of Pigeon!
Examples of situations that render a promissory note invalid
Let’s look at Amir and Alex to see what an invalid promissory note amendment looks like:
Thanks to the Right to Repair movement, Amir wants to create an electronic repair startup. 🤳🏽To get started, Amir borrows money from his former colleague, Alex. The loan’s full amount is for $5,000 paid in five installments over the course of a year. Alex amends the promissory note to be paid in eight months, but he fails to notify Amir about changes to the business loan.
Alex tries to take legal action against Amir. Since Amir never signed off on the amendments, the new version is invalid. Amir still has a full year until Alex can take legal action against him for non-payment, per the terms of the original agreement.
Now let’s take a look at an invalid unsecured promissory note with unreasonable terms:
Becca’s car died 🚗 and she needs a loan amount of $10,000 to buy a new vehicle. A long-time family friend Melanie agrees to lend the money. Rather than a lump sum, Melanie forms a promissory note requesting the money to be paid within a year over the course of six installments.
Becca signs, but she doesn’t realize Melanie included a really high-interest rate of 95%. This is well above normal interest rates and can invalidate the agreement due to unreasonable terms. This is considered a usurious loan. Once Becca realizes she’s paying an arm and a leg in interest, she takes Melanie to a mediator to renegotiate the interest rate. Melanie agrees to lower the interest and the loan is eventually paid in full.
What happens when a promissory note becomes invalid?
For the lender, an invalid promissory note may mean you can’t sue for any money the borrower promises but fails to pay.
The whole point of signing a promissory note is to create a legal document. That’s why you should make sure to avoid the eight things that can invalidate the document.
How different types of promissory notes are affected
MPNs: Anyone taking out federal student loans will use a master promissory note (MPN). An MPN is an overarching agreement. You can use it for all your student loans so you don’t have to sign a new one every school year. For borrowers, if your MPN is invalid, you won’t receive your student loans.
Other promissory notes: In general, an invalid promissory note is unenforceable. A lender cannot sue a borrower for unpaid debts. A promissory note provides protections for the borrower, too. An invalid note can discredit these protections.
How to make sure your loan agreement stays valid
If you want to make your promissory note rock-solid, consider this:
You can get your loan agreement notarized! A notary public signature acts as a third-party witness to your agreement. You’re not required to notarize a promissory note, and your note can still be valid without it.
Signatures are proof enough that your note is authentic. But some situations may benefit from having a notary witness.
Whether or not you take this extra step, you can use tools that help you craft valid loan agreements and get them signed. At Pigeon, we store your loan documents for you to access at any time. This makes it easy to get your promissory note signed by a notary public if you decide to do so.
Wrapping up: Avoid anything that can make your loan agreement invalid
From incomplete signatures to an expired statute of limitations, certain mistakes can invalidate a promissory note. Once invalidated, your written promise is no longer enforceable, making it an everyday IOU that you can’t take to court. 🤷🏻♀️
Don’t let that happen to you. Avoid these eight ways a promissory note can become invalid.
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