Promissory notes offer individuals additional investing options, and another way to diversify their investments. A promissory note is a debt-based financial instrument that involves one party making a written promise to repay a debt under specified terms. These specific terms usually involve a declared timeline or series of payments, or funds that are due upon demand. They could also include an interest rate and written consequences that will happen in case the borrower defaults.
The difference between one of these notes and an IOU is that an IOU only specifies the amount owed, a promissory note includes the amount owed, the steps needed to pay back the sum, and consequences that will ensue if the requirements are not fulfilled when payment is made.
These debt-based financial instruments can be issued by individuals or firms that are willing to lend out the money under the negotiated conditions. Companies can utilize promissory notes as an alternative method for obtaining credit when they have exhausted the other available options. Corporations have the ability to obtain various types of credit through myriad means including bond issues and loans from banks.
Promissory notes issued by a corporation generally carry higher default risk than bonds sold by the same organization. To compensate for this greater risk, a note would likely offer a higher return than a bond in order to entice investors.
Debt-based financial instruments such as these are only offered to savvy investors who have the needed resources to handle the risk and cost associated with notes such as these. An owner of one of these notes can resell the financial instrument or alternatively, sell the payments to another purchaser. Notes such as these that are resold are frequently done so at a discount to the instrument's original face value - to compensate for the impact on inflation on future payments.
Some people who face challenges in obtaining mortgages can utilize alternatives in order to buy real estate. The tough credit requirements imposed by many lenders have given rise to the existence of seller financing. One way for people who can't qualify for a mortgage to get a house is to utilize promissory notes.
The party that has the mortgage continues to hold the contract with the lending institution (taking it back) and the buyer signs a promissory note indicating that he will pay the price of the house plus an agreed-upon interest rate. The note will also specify the number and frequency of installments. This situation can result in a positive outcome for both the buyer and seller of the property.
For more information on how promissory notes work, schedule a free consultation with one of our SDIRA experts.