What is a Loan Note?
A loan note is an instrument that is issued by the lender to the borrower when the former grants loan to the latter. It also contains the payment terms and conditions, such as the rate of interest, tenure, amount of fine, in case of default, etc. In other words, a loan note contains all the legal bindings and obligations of both a lender and a borrower.
During a sanctioning of a loan, both the parties must be aware of the principal amount, payment terms and as well as the rate of interest attached to it. In order to remove all the future discrepancies, It is an essential means where a lender and a borrower can refer as per the aforesaid terms and conditions. Thus, both parties can settle their queries. A proper loan note provides evidence to both the parties depicting the terms and contract of the loan taken for a particular product or service by the borrower. The lender inspects the credit profile of the borrower followed by the mortgage, income tax details, etc.
How Does Loan Note Work?
It is a formal agreement between the lender and the borrower and both the parties sign an agreement consists of the followings:
- Amount of the loan
- Details of the mortgage such as price, depreciation, etc.
- The interest of the loan
- Fine or penalty attached to the loan
- Tenure of the loan followed by the amount of interest attached to it.
Difference Between Loan Note and Promissory Note
- A loan note is a secured form of debt instrumentDebt InstrumentDebt instruments provide finance for the company's growth, investments, and future planning and agree to repay the same within the stipulated time. Long-term instruments include debentures, bonds, GDRs from foreign investors. Short-term instruments include working capital loans, short-term loans., where the lender is abided by the terms and conditions and as well as the method of payment of the loan taken by him. While, on the other hand, a promissory notePromissory NoteA promissory note is a negotiable instrument that represents the debtor's or the writer's (the maker's) written consent to pay a promised sum to the creditor (the payee) on a specified date. is an unsecured form of contract wherein, the borrower is not deemed to repay the amount within the specified period of time.
- A promissory note is less formal in nature as compared to the loan note and is widely used in case of a smaller amount of loan amount. In case of a higher amount of loan taken by an individual or a corporate, a loan agreement becomes essential to claim the loan amount within the specified time frame.
- The loan note is a special means which helps a lender to recover, act and to claim a refund of the loan amount when a borrower defaults to pay the loan within the specified time frame.
- It is highly acceptable as compared to a promissory note and is legally much more viable. Thus, in case of default of a loan, legal action can be taken.
- A promissory note is an unsecured means of a contract between two parties and thus is applicable in case of a lower amount of loans. While, during a higher amount, the lender prefers to build a loan agreement with the borrower.
- Provides security to the borrower in case of claiming the principal amount during bad debtsBad DebtsBad Debts can be described as unforeseen loss incurred by a business organization on account of non-fulfillment of agreed terms and conditions on account of sale of goods or services or repayment of any loan or other obligation..
- This note further contains mortgage or security which is settled during the loan. Thus, in case of default, the borrower can get back the principal amount by selling the mortgage.
- The security level is higher in case of this note and thus the borrower needs to have a good credit rating and a higher rate of interest.
- A loan note is much more stringent as compared to a promissory note and involves a bigger amount as compared to the promissory note. Thus, the borrower cannot escape without the repayment of the loan.
- In case of the promissory note, in many cases, the lender gives a discount during the payment of the loan at the stipulated date while, in case of a loan note, the borrower is deemed to pay the principal amount along with the interest attached to it.
- The borrower is deemed to repay the entire amount, and in case of delay, a percentage of interest is charged on the remaining amount. While in the case of the promissory note, the model is unsecured in nature. Thus, if the borrower gets bankrupt, the lender can claim the proportionate amount which can be realized only by selling the remaining assets of the borrower.
- The rate of interest attached to this note is comparatively higher than a promissory note. Thus, the borrower has to pay a higher amount when a loan is taken through a loan note.
- A borrower needs a good credit rating if he wishes to obtain a loan note while in case of default, the lender can go to the court and file a lawsuit against the borrower.
A loan note is issued when the amount of loan is comparatively higher, and it is known as a secured mode of issuance of the loan. The lender receives a higher interest rate and hence a higher return on investment. While unlike unsecured loans, the loan note bears a higher amount of security as the credit profile of the borrower is comparatively better than the other modes of lending. Mortgage-Backed lending ensures the amount of security attached to this note.
This has been a guide to what is loan note and its meaning. Here we discuss how does loan notes work along with advantages and disadvantages. You may learn more about financing from the following articles –