What's the Difference Between a Loan Agreement and a Promissory Note?

Last revision: Last revision:21st January 2021
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Most Australians will have some experience with loans of some form or another. Even if you've never signed a formal document, you may have borrowed money from a friend or family member, or may have lent a few dollars here or there. If you're a business owner or a homeowner, or if you've taken out a loan to buy a car or other piece of equipment, then you might be a bit more familiar with typical loan documentation.

Loan documents can take a few different forms, but there are two that most people tend to think of: formal Loan Agreements and Promissory Notes.

What are the differences between these two types of documents? What are the similarities? Here, we'll discuss everything you need to know about Loan Agreements and Promissory Notes.

Please be advised that nothing in this guide is meant to constitute legal advice, and it should instead be taken as informational only.

What is a Loan Agreement?

First thing's first: what are these two documents, exactly? A Loan Agreement is a formal contract evidencing the loan of a certain amount of money from a lender to a borrower. There are several specific types of loan agreements, depending on what the loan is being given for. However, at its most basic level, this is a document that contains the terms between the lender and the borrower about the loan, the payback, the consequences of non-payment, and several other general contractual terms.

What is a Promissory Note?

A Promissory Note is a document from a borrower to a lender that basically says the borrower will promise (hence the name) to pay a certain amount of money.

What are the similarities between loan agreements and promissory notes?

Although there are important differences between Promissory Notes and Loan Agreements, they have a few critical similarities that need to be discussed first.

1. They both describe a sum of money to be paid back.

The most obvious similarity between the two is that they are both documents about money that needs to be paid. This is the primary reason that some people think of these two documents as interchangeable.

Some large financial institutions even use the term "note" to describe their loan agreements.

Both of these documents may be used in any situation where money needs to be paid back, but they are in fact each suited to slightly different situations.

Final takeaway: Both Promissory notes and Loan Agreements are, at their core, documents about a borrower that needs to pay back a lender for a specific sum of money.

2. They both bind the borrower.

Both Loan Agreements and Promissory Notes are formal legal documents, which the borrower signs. Once the borrower signs them, they become legally binding on the borrower. This means that if the borrower does not comply with them, there will be consequences (as described within the relevant document).

Final takeaway: Both of these documents are executed, or signed, by the borrower.

What are the differences between loan agreements and promissory notes?

Now that we're aware of the similarities between these two documents, let's talk about the differences.

1. Promissory notes are generally (but not always) used for more informal relationships.

In general, Promissory Notes are used for more informal relationships than Loan Agreements. A Promissory Note can be used for friend and family loans, or basic, small or short term loans.

Loan Agreements, on the other hand, are used for everything from vehicles to mortgages to new business ventures. Most banks and other large financial institutions have specific loan documents that they use for specific situations. Loan Agreements can also be used for basic loans, however, they often contain a number of more complex terms that some parties would prefer to leave out of their basic lending scenarios.

Final takeaway: Promissory Notes are usually used for less formal situations. Loan Agreements can be used for any money lending situation, but are usually used for larger or more complex loans.

2. Promissory notes may not be signed by the lender.

As alluded to above, although the borrower signs both documents, Promissory Notes are often not signed by the lender.

In fact, the clue is in the names. You can think of a "Promissory Note" as a promise to pay a sum of money. The borrower is making that promise, so they sign the document.

On the other hand, a Loan Agreement is an agreement that the lender will lend a sum of money, and that the borrower will repay it in the manner described in the document. Both parties are agreeing to these terms, so they both sign the document.

Final takeaway: Lenders may not sign Promissory Notes, but they do tend to sign Loan Agreements.

3. Loan agreements are usually much more complex.

Loan Agreements are usually longer and more complex than Promissory Notes. They often have to be because of the very specific terms needed for large, complex loans. That isn't to say that Promissory Notes can't be complex, it's just that as a general matter, Loan Agreements are usually the more complex out of the two.

Final takeaway: Promissory Notes are generally less complex than Loan Agreements.

In conclusion

As you can see, although Loan Agreements and Promissory Notes do have some similarities, they are not exactly interchangeable documents. It's important to know the differences between the two so you can ensure you are using the right type of agreement for your needs.

As always, if you have specific questions, or are considering which document to use for a complex transaction, it's a good idea to seek legal advice.

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