How to Write a Promissory Note: Clauses, Signing, and Taxes

To write a promissory note, put every term of the loan in a single signed document: the full legal names and addresses of the lender and borrower, the exact principal, the interest rate, the repayment schedule, and the state whose law governs the agreement. Add a few protective clauses, keep the interest rate above the federal minimum and below your state’s usury cap, and have the borrower sign. That’s the short version. The rest of this article walks through each decision you’ll make along the way.

Information to Gather First

Start with the people. You need the full legal names and current mailing addresses of both the lender (the payee or holder) and the borrower (the maker). Legal names, not nicknames. If the borrower falls behind later, those addresses are where notices and legal papers get served.

Next, the money. Write the principal as both a numeral and words: “$15,000 — Fifteen Thousand Dollars.” Doing it twice makes tampering harder. Record the date the loan is issued, because that date anchors the repayment timeline and the moment interest starts running.

Finally, pick a governing state. States differ on interest caps, default remedies, and how long the lender has to sue. Naming one state up front prevents an argument later, especially if the lender and borrower live in different places.

Pick How the Loan Gets Repaid

Three structures cover almost every private loan:

Installment payments. The borrower pays a fixed amount on a regular schedule — monthly, quarterly, or another interval — until the balance is gone. This is the most common structure for personal loans and gives both sides predictability.
Balloon payment. The borrower makes smaller periodic payments (often interest-only) during the term, then pays the entire remaining balance in one lump sum at maturity. Low monthly cost, but the borrower has to come up with a large sum at the end.
Demand note. No fixed schedule. The lender can call for the full balance at any time, and the borrower must pay after receiving that demand. Maximum flexibility for the lender, less certainty for the borrower.

Also spell out how each payment is applied. A standard order runs first to any accrued fees or costs, then to interest, and finally to principal. Putting that in writing prevents disputes about how much principal is left after every payment.

Set an Interest Rate That’s Legal on Both Ends

You and the borrower can agree on a fixed rate that stays constant for the life of the loan, or a variable rate that adjusts based on a published index like the prime rate. Express the rate as an annual percentage so it’s directly comparable to other loans.

Two boundaries matter.

The Federal Floor

Charge too little and the IRS treats it as a below-market loan. Under 26 U.S.C. 7872, a loan carrying less than the Applicable Federal Rate (AFR) generates “imputed interest”: the IRS acts as though the lender collected interest at the AFR even if they didn’t.¹ As of January 2026, the AFR is 3.63% for short-term loans of three years or less, 3.81% for mid-term loans of three to nine years, and 4.63% for long-term loans over nine years.² The IRS updates these monthly, so check the current figure before finalizing.

Small gift loans between individuals get a break: if the total outstanding balance between the same two people stays at or below $10,000, the imputed-interest rules don’t apply, as long as the borrower isn’t using the money to buy income-producing assets like stocks or rental property.¹

The State Ceiling

Every state also caps how much interest a private lender can charge. These usury limits vary widely — statutory caps run from around 5% to over 25% depending on the state, the type of loan, and whether the agreement is written. Charging above the cap can void the excess interest, expose the lender to damages (sometimes double or triple the interest paid), or in extreme cases make the whole note unenforceable. Check the usury limit in the state whose law governs your note before you settle on a rate.

Clauses That Protect the Lender

A promissory note template from a state bar association or a reputable legal provider will give you a structured starting point. Fill in every blank, even fields that look optional, so nothing can be altered after signing. Beyond the basic terms, a handful of clauses do most of the heavy lifting if things go wrong.

Acceleration

An acceleration clause lets the lender demand the entire unpaid balance immediately if the borrower misses a payment or violates another term. Without it, the lender can only sue for each missed payment as it comes due. With it, one default puts everything — unpaid principal plus accrued interest — on the table at once.

Late Fees

A late fee clause charges a penalty when a payment arrives after a set grace period, commonly five to fifteen days past the due date. The fee is usually a flat dollar amount or a small percentage of the overdue payment. Keep it reasonable; courts in many states won’t enforce penalties they view as excessive.

Prepayment

Decide whether the borrower can pay off the loan early, and whether early payoff costs anything. A prepayment penalty compensates the lender for interest income lost when the debt retires ahead of schedule, and it’s often calculated as a percentage of the remaining balance or a set number of months’ interest. Many personal loans between individuals allow prepayment with no charge. Either way, state your choice explicitly.

Governing Law and Dispute Resolution

Name the state whose law governs and where disputes will be resolved (for example, the county where the lender lives). Some notes also require mediation or arbitration before either side can sue, which can save time and legal costs.

Decide Whether to Secure the Note

An unsecured note relies entirely on the borrower’s promise to pay. If they default, the lender sues, wins a judgment, and then has to collect on it. A secured note ties the loan to a specific asset — a vehicle, equipment, real estate — that the lender can take if the borrower stops paying.

Three things create a valid security interest: the lender gives value (the loan itself counts), the borrower has rights in the collateral, and the borrower signs a security agreement describing the collateral.³ The security agreement can live inside the promissory note or in a separate document.

To protect the lender’s position against other creditors, you generally have to “perfect” the security interest. For most personal property, that means filing a UCC-1 financing statement with the appropriate state office, usually the secretary of state. The financing statement lists the borrower’s name, the lender’s name, and a description of the collateral.⁴ For real estate, record a deed of trust or mortgage with the county recorder’s office instead. Whoever perfects first generally gets paid first if several creditors are chasing the same borrower.

Sign, Notarize, and Store the Note

The note becomes binding when the borrower signs it. The lender’s signature isn’t always legally required, but having both parties sign reinforces mutual agreement.

Ink or Electronic

Either works. Under the federal Electronic Signatures in Global and National Commerce Act, an electronic signature can’t be denied legal effect solely because it’s electronic, provided both parties consent to transacting that way.⁵ Some lenders still prefer ink, particularly if they might later sell the note, because certain secondary-market purchasers require wet signatures.

Notarization

Most states don’t require a promissory note to be notarized. It’s still worth doing. Under Federal Rule of Evidence 902, a document accompanied by a notary’s certificate of acknowledgment is “self-authenticating,” meaning it can be introduced in court without calling a witness to verify the signatures.⁶ Notary fees are modest, typically under $25 per signature. If the note is secured by real estate, notarization is usually required anyway so you can record the associated deed of trust or mortgage.

Witnesses

One or two witnesses aren’t legally required in most situations, but their signatures make later claims of coercion or forgery harder to sustain.

Storage

Give the original signed note to the lender. The lender needs the original to prove the debt exists and to enforce it in court. The borrower keeps a complete copy, including all signatures and attachments. A fireproof safe or safe deposit box is appropriate for both.

Taxes the Lender Should Expect

Interest you receive as a lender is taxable income and has to be reported on your federal return regardless of the amount. If the interest from one borrower reaches $10 or more in a calendar year, you also have to file a Form 1099-INT with the IRS and give the borrower a copy.⁷

Imputed interest is the other trap. If your rate is below the AFR, the IRS treats you as having earned interest at the AFR anyway, and the shortfall is treated as a gift from you to the borrower.¹ If that gift, combined with anything else you give the same person that year, exceeds the annual gift tax exclusion of $19,000, a gift tax return may be due.⁸

For gift loans between individuals where the balance stays between $10,000 and $100,000, imputed interest can’t exceed the borrower’s net investment income for the year. If that net investment income is under $1,000, it’s treated as zero, which effectively removes the imputed-interest issue for that year.¹

If the Terms Need to Change Later

People’s circumstances shift. The borrower may need longer to repay, or both sides may want to adjust the rate. Don’t tear up the original. Sign a written amendment (sometimes called a modification or addendum) that identifies the original note by date and principal, describes exactly which terms are changing, and states that everything else stays in effect. Both parties sign, and the amendment gets stored with the original note. A verbal change is hard to prove and often unenforceable, so put every modification in writing.

Making the Note a Negotiable Instrument

A promissory note works as an ordinary contract, but it gets stronger legal treatment if it qualifies as a “negotiable instrument” under Article 3 of the Uniform Commercial Code. A negotiable note can be sold or transferred to a third party, and the new holder may take it free of many defenses the borrower could have raised against the original lender. To qualify, the note must meet all of the following:⁹

Unconditional promise. A straightforward promise to pay, not one that depends on something else happening first (like a sale closing).
Fixed amount of money. A specific dollar figure for principal; interest and other charges can sit on top.
Payable to bearer or to order. Language like “payable to the order of [lender’s name]” or “to bearer.” Without it, the note is still a valid contract but isn’t negotiable.
Payable on demand or at a definite time. Either a maturity date or a statement that payment is due when the lender demands it.
No extra undertakings. The borrower can’t be required to do anything besides pay money, with narrow exceptions for protecting collateral.

If you don’t plan to sell the note, you don’t need to hit every negotiability box. Following these rules anyway produces a cleaner document that other people will recognize.

One Boundary Worth Knowing

A note doesn’t stay enforceable forever. Every state imposes a statute of limitations on suing after default. Under the version of UCC Section 3-118 adopted in most states, the deadline is six years from the due date for notes payable at a definite time, or six years from the date payment is demanded on a demand note. If neither principal nor interest has been paid on a demand note for ten continuous years and no demand has been made, the right to sue is typically barred entirely. Deadlines vary by state, so confirm the local rule before assuming there’s still time.

1
Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans with Below-Market Interest Rates
2
Internal Revenue Service. Revenue Ruling 2026-2 – Applicable Federal Rates
3
Cornell Law School. Uniform Commercial Code 9-203 – Attachment and Enforceability of Security Interest
4
Cornell Law School. Uniform Commercial Code 9-502 – Contents of Financing Statement
5
Office of the Law Revision Counsel. 15 U.S. Code 7001 – General Rule of Validity
6
Cornell Law School. Federal Rules of Evidence Rule 902 – Evidence That Is Self-Authenticating
7
Internal Revenue Service. About Form 1099-INT, Interest Income
8
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
9
Cornell Law School. Uniform Commercial Code 3-104 – Negotiable Instrument