Demand notes serve as flexible loan agreements for private parties, usually for small sums of money. But they can be issued by banks on rare occasions. Learn how demand notes work, what their requirements are, and how to handle one if you’re the borrower or the lender.
Definition and Example of a Demand Note
A demand note is a type of promissory note that’s a special loan between private parties where borrowers don’t pay interest or a fixed amount on a repayment schedule. The borrower instead promises to pay the loan back in full when the lender, usually a family member or friend, notifies them or “demands” that they do so. Demand notes are most common among family members. Let’s say a parent lends their adult child money to start a business. The parent writes a demand note in exchange for the loan. Both parties create and agree on the terms in advance. They decide on a five-year repayment plan with no interest and 60-day advance notice before demanding repayment. The parent and child both sign the demand note before the transaction.
How Does a Demand Note Work?
Demand notes tend to be most common among people who know each other due to the notes’ casual nature. They primarily benefit the borrower, but agreements are subjective and offer flexible, broad terms that are favorable to the lender as well. Terms may include the principal to be repaid, interest (if any), and a period of advance notice required before the lender can demand repayment. All details are agreed on in advance and included in the note. Demand notes usually don’t have fixed terms, a minimum or maximum amount, interest, or repayment requirements. The parties involved determine the desired terms and sign the note before the borrowing process begins. The lender then issues the money and holds the demand note until payment is due. Let’s say your best friend is in a bind, and you decide to loan them $1,000. You discuss the loan terms before lending the money. You both agree they will pay you back within two years with no interest. You may also stipulate that you can request payment on demand with 30-day advanced notice. You draw up a demand note, and you both sign it to agree to the terms. “Under most demand notes, it is possible for the borrower to enjoy use of the funds for many years without ever making a payment,” said David Frederick, director of client success and advice at First Bank. Frederick said that demand loans are also common in estate planning. Grantors can sell assets into a trust in exchange for a demand note. The demand note gives the grantor the right to demand payments from the trustee whenever they need to. “In this way, a demand note allows a person to fund a trust but still maintain an option to take economic value back out of the trust,” Frederick said. Demand notes usually are informal agreements between private parties, so there’s no legal contract. This means the loan is unsecured and not backed by the FDIC. As a result, demand notes generally are not enforceable by law. However, a signed official loan agreement can usually be subject to legal enforcement in the rare case of a bank-issued demand note. Frederick said that while banks may offer a demand note to clients with a history of creditworthiness, they’re rare because banks usually want to be paid back on fixed terms and over a fixed period of time. Parties interested in drawing up a demand note can find free templates online.
