A demand note is a promissory note with no set repayment date that the lender can call due in full at any time, for any reason. That single feature is what makes it different from almost every other kind of loan you might sign. There’s no amortization schedule, no maturity date, and no requirement that the lender wait for a missed payment or a change in your finances before asking for the money back. The tradeoff is flexibility on both sides: the borrower isn’t locked into fixed monthly payments, and the lender keeps the ability to pull the funds when circumstances shift.
How a Demand Note Differs From a Term Loan
Under the Uniform Commercial Code, a note is “payable on demand” if it says so explicitly or if it simply doesn’t state any time for payment at all.1Legal Information Institute. UCC 3-108 – Payable on Demand or at Definite Time So a bare IOU with no repayment schedule is technically a demand instrument, whether the parties thought about it that way or not.
A term loan locks in specific repayment dates and an amortization schedule. You know from day one when each payment is due and when the loan ends. A demand note gives you none of that. In legal theory, the debt is due the moment the note is signed; in practice, the lender holds off on collecting through an unspoken agreement to wait. That arrangement continues until the lender formally calls the note or the borrower pays voluntarily.
The planning consequence is real. A term loan lets you budget around fixed payments. A demand note requires you to be ready, at least in theory, to come up with the full balance on short notice.
What Makes a Demand Note Legally Valid
To qualify as a negotiable instrument with full UCC protections, a demand note must contain an unconditional promise to pay a fixed amount of money, be payable to a specific person or to bearer, and be payable on demand. It also can’t require the borrower to do anything beyond paying the money owed.2Legal Information Institute. UCC 3-104 – Negotiable Instrument
A few additions are permitted without wrecking negotiability. The note can require the borrower to maintain collateral, authorize the holder to seize collateral on default, and waive certain legal protections. Tacking on obligations beyond payment converts the document into an ordinary contract rather than a negotiable instrument, which makes it harder to transfer and enforce.2Legal Information Institute. UCC 3-104 – Negotiable Instrument
If you don’t want the note sold or assigned to a third party, include a conspicuous statement that it is not negotiable. Without that language, the lender can transfer the note, and the new holder steps into the same right to demand payment.
Interest, Collateral, and Prepayment
Interest accrues on the outstanding principal, and there’s no rule that a demand note carry a variable rate. It can be fixed, variable, or zero, as long as the rate complies with applicable usury laws. The note should spell out the rate, how interest is calculated, and when interest payments are due, whether monthly, quarterly, or accrued until the note is called.
A demand note can be either secured or unsecured. A secured note requires the borrower to pledge specific assets as collateral, and if the borrower fails to pay when the note is called, the lender can seize and sell that collateral under the UCC’s rules for secured transactions.3Legal Information Institute. UCC Article 9 – Secured Transactions An unsecured note relies on the borrower’s promise alone, which forces the lender to sue and win a judgment before collecting.
Most demand notes let the borrower prepay principal, in whole or in part, at any time without penalty. That’s one of the borrower’s few levers: paying down the balance when cash is available reduces interest costs and shrinks the amount that could be called due later.
When Demand Notes Are Actually Used
Demand notes tend to show up where the parties already trust each other or where the financing need is genuinely open-ended.
- Family loans. A parent lending money to a child for a home purchase or a business startup is the classic case. The parent doesn’t want rigid deadlines, and the child benefits from flexible terms. These arrangements need attention to IRS rules to avoid being reclassified as a taxable gift.
- Short-term corporate financing. A business facing an unexpected inventory purchase or a temporary gap in receivables can use a demand note to access funds quickly without negotiating a full term loan agreement.
- Intercompany transfers. A parent corporation can use demand notes to move cash to subsidiaries and keep the ability to pull the money back if the subsidiary’s financial condition weakens, without renegotiating formal loan terms.
Tax Rules for Below-Market Family Loans
When a demand note charges interest below the IRS’s Applicable Federal Rate, both parties can end up with tax consequences they didn’t expect. Under Section 7872 of the Internal Revenue Code, the IRS treats the difference between the AFR and whatever the note actually charges as “forgone interest.” That gap is taxed as if the lender gave the money to the borrower and the borrower paid it back as interest, even though no cash changed hands.4Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates
For a family demand note, this creates a two-part fiction. The forgone interest is treated first as a gift from the lender to the borrower, then as an interest payment from the borrower back to the lender. The lender owes income tax on the phantom interest, and the forgone amount counts toward the annual gift tax exclusion. These deemed transfers happen on the last day of each calendar year.4Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates
The IRS publishes updated AFR rates monthly, broken out by loan term. For demand loans, the short-term AFR applies. As of early 2026, the short-term AFR is approximately 3.59% annually.5Internal Revenue Service. Applicable Federal Rates Charging at least this rate avoids the imputed interest rules entirely.
There’s a meaningful exception for small loans. Section 7872 doesn’t apply to gift loans between individuals when the total outstanding balance stays at or below $10,000, unless the loan is used to buy or carry income-producing assets.4Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates The same $10,000 threshold applies to compensation-related and corporation-shareholder loans, though the exception disappears if tax avoidance is one of the principal purposes of the arrangement.
How the Lender Calls the Note
Under the UCC, a demand for payment can be made by any commercially reasonable means, including oral, written, or electronic communication, and it takes effect when the borrower actually receives it.6Legal Information Institute. UCC 3-501 – Presentment Writing isn’t legally required, but proving the demand was made matters enormously if the borrower doesn’t pay and the dispute lands in court. Certified mail with return receipt produces a signed, dated record.
Many demand notes build in a notice period, commonly 10 to 30 days, giving the borrower time to arrange payment after the call. If the note doesn’t specify one, the borrower may still get a reasonable time to pay under general contract principles. Once that window closes, the full balance is overdue.
The moment the lender formally calls the note, the instrument transforms from a flexible, open-ended arrangement into a fixed obligation. If the note is secured, the lender’s rights to the collateral become enforceable once the notice period expires.
Risks Before You Sign
The biggest risk is easy to underestimate: the lender can call the entire balance due at any time, for any reason. The UCC’s good faith requirement for accelerating a term loan, which requires the lender to genuinely believe repayment is at risk, does not apply to demand notes.7Legal Information Institute. UCC 1-309 – Option to Accelerate at Will Calling a demand note isn’t acceleration; the note was always due on demand. That’s the whole point of the instrument.
A lender can call the note even when the borrower is current on interest and the underlying business is healthy. Courts have generally upheld this, even when the call forces the borrower into financial distress. Some borrowers have argued that calling a note without cause is bad faith, and a handful of courts have been sympathetic, but the weight of authority favors the lender’s contractual right to call at will.
The practical takeaway: don’t sign a demand note for an amount you couldn’t realistically repay on short notice, unless you have a clear understanding with the lender about what would actually trigger a call. That understanding is only as good as the relationship. If the lender’s circumstances change, a new loan officer takes over, or the note gets transferred to a third party, an informal agreement to let the note ride can evaporate overnight.
How Long a Demand Note Stays Enforceable
A demand note doesn’t stay collectible forever. Under UCC Section 3-118, if the lender never makes a demand and neither principal nor interest has been paid for a continuous period of 10 years, the right to enforce the note expires.8Legal Information Institute. UCC 3-118 – Statute of Limitations Once the lender does make a demand, a separate limitations period starts running on the right to sue. The length of that post-demand period varies by state, but six years is common.
This clock matters in family lending. If a parent lends money to a child, no payments are made, and no demand is ever issued, the note becomes legally unenforceable after a decade. Even a small interest payment restarts the clock.
What Happens After Default
If the borrower doesn’t pay after the note is called and the notice period has passed, the lender’s next step depends on whether the note is secured. For a secured note, the lender can enforce the security interest in the pledged collateral under UCC Article 9, repossessing and selling it and applying the proceeds to the debt.3Legal Information Institute. UCC Article 9 – Secured Transactions Any surplus goes back to the borrower; any shortfall can be pursued as a deficiency.
For an unsecured note, the lender’s only option is a lawsuit for the debt. A judgment can then be enforced through wage garnishment, bank levies, or liens on the borrower’s property, depending on the jurisdiction. On a small note, the cost of suing may not justify the recovery.
What Happens When a Party Dies
A demand note survives the death of either party. If the borrower dies, the debt becomes an obligation of their estate, and the executor is responsible for paying it from estate assets before distributing anything to heirs. Family members aren’t personally liable unless they co-signed. If the estate doesn’t have enough assets to cover all debts, the note holder may recover only a fraction, or nothing at all if higher-priority creditors consume the available funds.
If the lender dies, the note becomes an asset of the lender’s estate. The executor can collect on it, call it due, or distribute it to heirs under the will or state inheritance laws. A note held in a revocable living trust passes to the trust’s beneficiary outside of probate. When the note lacks clear language about successors or assigns, probate court involvement may be needed before anyone can collect. Informal or poorly documented notes are especially vulnerable, because the borrower can dispute the terms once the original lender is no longer around to confirm them.