Section 8.1 Loans and Interest
265
A loan is usually formalized by a legal document called a promissory note. A
promissory note is a written promise, or contract, to pay back a loan. The amount
of the principal, the interest rate, and the terms of the loan are all specifi ed in the
promissory note. Figure 8-1 shows an example of a promissory note.
Sometimes a lender requires something of value to be pledged as security
for a loan. For example, suppose Natalie wants to borrow $5,000. She owns a
car with a value of $8,000, which is paid in full. Before granting the loan, the
lender may require that the car be pledged as security. The car is being used
as collateral for the loan. Collateral can be any asset worth money, including
a house, a car, or a possession. Securing a loan with collateral means that in
the event you default on the loan, the lender will receive the asset pledged as
collateral.
When property is used as collateral, the lender will place a lien on it. A lien
is a legal agreement giving the lender the right to claim assets of the borrower
if necessary to repay a loan. In Natalie’s case, this means that if the lender is not
repaid, the car could be sold to repay the loan.
fyi
The Truth in Lending
Act (TILA) requires
every lender to provide
the borrower with
information about the
cost of credit. This act
applies not only to banks,
but also to all lenders
who extend credit to
consumers, such as retail
stores. The Consumer
Financial Protection
Bureau enforces the
provisions of the Truth in
Lending Act.
Promissory Note
Promise to Pay. For value received, Helen Williams promises to pay
Barbara Williams, $5,000.00 and interest at the yearly rate of 5%.
Borrower will pay one lump payment one year from the date of
execution of this document.
The undersigned agrees that this note is governed and enforced in
accordance with the laws of this state.
Borrower: Date:
Helen Williams March 1, 20--
Date of
note
Borrower
Lender
Number of
installments
Rate of
interest
Principal
Due date
Figure 8-1.
Promissory Note