What is a Loan Note?

Explanation

During a sanctioning of a loan, both parties must be aware of the principal amount, payment terms, and the rate of interest attached to it. To remove all future discrepancies, it is an essential means where a lender and a borrower can refer to the terms mentioned earlier 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. First, the lender inspects the borrower’s credit profile, followed by the mortgageMortgageA mortgage loan is an agreement that gives the lender the right to forfeit the mortgaged property or assets in case of failure to repay the borrowed sum and interest.read more, income tax details, etc.

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How Does Loan Note Work?

It is a formal agreement between the lender and the borrower, and both the parties sign an agreement consisting of the followings:

  • Amount of the loanDetails of the mortgage such as price, depreciation, etc.The interest of the loanFine or penalty attached to the loanTenure 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.read more, where the lender is abided by the terms and conditions and the method of payment of the loan taken by him. While on the other hand, a promissory notePromissory NoteA promissory note is defined as a debt instrument in which the issuer of the note promises to pay a specified amount to a party on a particular date.read more 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 than a loan note and is widely used in the case of a smaller 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.

Advantages

  • The loan note is a special means that helps a lender recover, act, and claim a refund of the loan amount when a borrower defaults to pay the loan within the specified time frame.It is highly acceptable compared to a promissory note and is legally much more viable. Thus, legal action can be taken in case of default of a loan.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.read more.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 the case of this note, and thus the borrower needs to have a good credit rating and a higher rate of interest.

Disadvantages

  • A loan note is much more stringent than a promissory note and involves a larger amount than the promissory note. Thus, the borrower cannot escape without the repayment of the loan.In the case of the promissory note, the lender gives a discount during the payment of the loan at the stipulated date. While, in the case of a loan note, the borrower is deemed to pay the principal amount along with 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. 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 court and file a lawsuit against the borrower.

Conclusion

A loan note is issued when the loan amount is comparatively higher, and it is known as a secured mode of issuance of the loan. As a result, the lender receives a higher interest rate and a higher return on investment. While unlike unsecured loansUnsecured LoansAn unsecured loan is a loan extended without the need for any collateral. It is supported by a borrower’s strong creditworthiness and economic stabilityread more, the loan note bears a higher amount of security as the borrower’s credit profile 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 loan notes and their meaning. Here we discuss how loan notes work along with advantages and disadvantages. You may learn more about financing from the following articles –

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