What Is an Interest-Bearing Note Payable?

Interest-bearing notes payable are used to borrow money for many reasons

Interest-bearing notes payable are used to borrow money for many reasons

Borrowing money to finance a business, buy a house or car, or for any other reason generally includes a cost to the borrower. That cost is interest -- the difference between the amount borrowed and the amount that must be repaid. The amount of interest depends on the borrower’s creditworthiness and the length of the loan.

Definition of Note Payable

A debt is usually evidenced by a promissory note, defined by the online Free Dictionary as a “Written, signed unconditional promise to pay a certain amount of money at a specified time.” The face of the note is the amount borrowed. Interest is added to each payment on the unpaid balance. The interest rate is usually stated as an annual percentage.

How It Works

For example, assume you borrow $10,000 for 10 years at an annual interest rate of 6 percent, with payments to be made every three months (quarterly payments). Your payments would be $250 in principal each quarter. In addition, you would pay 1.5 percent in interest with each quarterly payment (6 percent divided by 4). Your first payment would total $400 ($250 in principal plus 1.5 percent of $10,000, or $150). Your second payment would include $250 in principal plus $146.25 in interest (1.5 percent of $9,750). This would continue for 10 years, with an equal amount of principal and a declining amount of interest paid each quarter.

Collateral

In many cases, lenders require a security interest in property. Perhaps the best example is a mortgage loan used to purchase a home. The lender will take a security interest in the home, so if the loan is unpaid, the lender will become the owner of the home. Businesses borrow money for working capital or to acquire inventory or equipment. The amount of security the borrower requires depends on several factors, including the experience of management, the profitability of the business, the credit rating, and a clear business plan for the use of the borrowed money.

Other Considerations

It pays to shop around to get the most favorable borrowing terms. You may want a variable rate of interest rather than a fixed rate if you feel interest rates may drop in the future. You may want a shorter or longer term, depending on the affordability of the periodic payments. You should ensure that you will have the option to prepay the loan without any penalty if you find yourself in a position to do so.

 

About the Author

Richard Friedkin has many years of experience as a Certified Public Accountant, a Certified Financial Planner and a corporate CEO. He has been a writer for more than 30 years, writing everything from dense technical memos to whimsical children's stories. Friedkin's work has been published locally and performed on stage.

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