If you’ve ever taken out or are planning to take out a loan, you must be familiar with the term ‘loan note’. Simply put, a loan note refers to the contract, signed by the lender and borrower alike. This contract encompasses all details of the loan, such as the loan term, loan amount, interest rate and legal obligations. But what purpose does a loan note serve? Herein, we’ve answered 4 common questions about loan notes, to help you grasp the concept.

What is a loan note?

If you’re aware of the concept of an I Owe You (IOU) document, it’ll be easier for you to understand what a loan note is. A loan, fundamentally, is an extension of an IOU document. Loan note allows a borrower to loan money from a lender over a predetermined loan term, with an interest rate. Along with this, your note would contain details about the date of final repayment. A borrower often uses a loan note as a substitute to cash.

A loan note represents the contract that defines the legal obligations of the lender and the borrower. This legally binding contract would ideally include a set of penalties. So, a lender or a borrower could get penalized on failing to meet the obligations.

How does a loan note work?

So far, we’ve established that a loan note is a type of a promissory agreement. A promissory note is simply a promise made by the borrower, to repay the loan in full, as per the terms stated in the agreement.

A loan note contains all terms associated with the loan. Both parties involved in the agreement have to commit to the terms outlines in the loan. Even you, as a borrower, are free to draw up a loan note. Although, conventionally, it’s the lender that creates and completes this agreement. A loan note will lose it’s validity as soon as the borrower pays off the entire amount listed in the agreement, to the lender.

What information does a loan note contain?

A loan note would comprises of all the appropriate and relevant details concerning the loan agreement between the lender and borrower. This would include personal details, such as the names and contact information of both, the lender and borrower. Additionally, a loan note will contain the principal loan amount, interest rate charged on the loan, the tenure of the loan as well as the repayment schedule. Most of these details are decided when the lender and the borrower reach an agreement. Therefore, the document mentions the repayment arrangement and the date on which the borrower will pay the last instalment.

Since this document legally binds both the parties, it defines the penalties that they can be charged if they fail to oblige to the agreement. For instance, the consequences of late repayments or premature settlement of the loan.

Loan notes defines the repercussions of a premature settlement to protect the lender from losing out on the payable interest. However, lenders only levy a charge if a loan is settled before a specified time period. For instance, this could the first 4 years of the loan term. Therefore, the lender may not charge you if you prematurely settle the loan after this specified time period. Although, different lenders draw up different terms, so it is wise to check your agreement beforehand.

Are there any advantages of a loan note over a normal agreement?

  • Loan notes can be a good way for businesses to get seed funding, without losing their equity. Startups often use loan notes to gather seed capital from their friends or family, to start their business. So even if you were to lose some equity, the loan note is organized in such a way that it may be given away upon a certain event.
  • They are often more flexible than a typical agreement, especially in terms of settlement. This is because you’ll be able to repay the debt before insolvency.
  • You can issue loan notes to multiple holders. This makes more sense from a business point of view, since there may be multiple investors involved.

Key Takeaways

  • A loan note is like a promissory agreement which defines the legal obligations associated with a loan. This is applicable for both parties involved – the lender and the borrower.
  • This document encompasses all details pertaining to a loan – the amount, the tenure, the interest, payment schedule, due date and default penalties.
  • Most lenders use loan notes when they lend a large funds for expensive purchases – a car or house, per se.
  • Loan notes are beneficial for startups seeking seed funding to set up their business.
  • Loan notes often hold more legal weightage than a traditional IOU document. In case of a disagreement or breach, you may uphold a loan note in court, since it holds more legal significance.