Promissory Notes, Defined And Explained
Scott Steinberg5-minute read
January 24, 2022
When borrowing money from a lender to buy a home, you’ll come across a set of complex legal and financial jargon that may be unfamiliar to you. One such term is “promissory note,” which will definitely come up if you are using lender money to finance your home purchase. Don’t let this term confuse you – a promissory note is essentially just a legal document where you, the borrower, formally agree in writing that you’ll repay the loan.
What Is A Promissory Note?
A promissory note is a written agreement between one party (you, the borrower) to pay back a loan given by another party (often a bank or other financial institution). Anyone lending money can issue a promissory note (like home sellers, credit unions, FinTech solutions, and nonmortgage-related banks, for instance) but specific to real estate and the mortgage process, promissory notes serve as an agreement that the borrower will repay their mortgage loan by the maturity date.
A promissory note is, ultimately, a legal document outlining the terms of the agreement, but within the document is also all the relevant information of the loan: who the borrower is, the lender, and the terms of the agreement. Common items contained within a promissory note include:
- Total amount of money to be borrowed
- Interest rate being charged
- Monthly payment amount
- Number of required payments
- Frequency with which payments will be made
- Any collateral that will be put up
- Date and location of note issuance
Promissory notes are different from loan contracts. Like promissory notes, loan contracts are also legally binding and provide a detailed rundown of the financial particulars of the loan, but they are different in that a loan contract will define how any defaults or breaches of loan terms (like late or missing payments) will be addressed.
How Do Promissory Notes Relate To Mortgages?
Promissory notes are just one part of the complex financial and legal process of buying a home. While it may look like a simple stack of paper at closing, each document serves a purpose.
As part of the home loan mortgage process, you can expect to execute both a legally binding mortgage and mortgage promissory note, which work toward complementary purposes. Entering into a mortgage empowers your lender to hold a security interest in your real estate property in case the full amount of the loan plus interest is not paid back. A home mortgage effectively secures a promissory note with the title to the property in question in case the lender should need to foreclose and sell the property in event of nonpayment.
Your lender will keep the original promissory note until your loan is paid off. However, you will also receive a copy of your mortgage and your promissory note with the remainder of your closing documents when you close on the purchase.
Note: When applying for a mortgage online (through Rocket Mortgage® for example) a promissory note will be called an eNote, but it is essentially the exact same thing.
FAQ: Other Questions About Promissory Notes
Why do lenders use promissory notes?
A promissory note is used by a lender as a way to ensure there is legal recourse in the event you do not repay the loan. While many homeowners think they’re paying off the mortgage loan to officially “own” their home, it is actually the promissory note the lender holds until the mortgage repayments are complete that gives them the power to foreclose in the event of default.
Without a legally binding promissory note, a financial institution may not have any legal recourse to foreclose on the home or attempt to get their money back. Often, promissory notes are sold (along with mortgages) on the secondary mortgage market. While a promissory note could get lost in the shuffle of institutions selling loans to secondary lenders, it doesn’t mean you’re off the hook for the amount, as the legal obligation to pay the loan still exists.
Laws vary by state, but a lender may reinstitute a promissory note in some instances.
What’s included in a promissory note?
While each state has its own individual rules governing what must be included in the document, standard items that you might expect to see contained within a promissory note include:
- Borrower name and contact information
- Lender details and contact info
- Principal loan amount
- Interest rate and how it’s been calculated
- Date first payment is required
- Loan maturity date
- Date and place of issuance
- Fees and charges
- Repayment terms and options
- Loan conditions
- Borrower’s signature (this is what makes it legally binding!)
What are the different types of promissory notes?
There are a handful of types of promissory notes, such as secured, unsecured and the aptly titled Master Promissory Note (MPN.)
Can I get a promissory note without a mortgage?
Yes, it’s possible to have a promissory note without a mortgage, if you are evaluating alternative forms of debt to finance your home purchase. In fact, a promissory note may be a way for someone who is unable to obtain traditional financing to still buy a home through what is called a take-back mortgage.
A take-back mortgage effectively allows the home seller to become a lender. If they have the means to do so, a seller can loan a buyer money to purchase the home. In order to do this, the home must be owned outright by the seller (not currently under monthly mortgage), and the buyer (aka the borrower) is required to make regular payments to the seller. It’s the same structure as under a standard home loan through a bank, though typically these loans come at higher interest rate.
Under the terms of a take-back mortgage, the seller retains a proportionate share of equity in the home until the buyer pays back their home loan plus interest in full. As when applying for a traditional mortgage, a promissory note is signed which obligates the buyer to make principal and interest payments according to a preset schedule. Should the buyer default on payments, the seller can foreclose on the property and sell the home.
Secured vs. Unsecured
A promissory note can be secured or unsecured. A secured promissory note requires the borrower to safeguard the loan by putting up items of hard value, such as the home, condominium, or rental property itself as collateral to ensure that sums are repaid.
An unsecured promissory note does not come with these upfront requirements, though you are still obligated to repay the loan. Most commonly, a promissory note will be secured by the home you are purchasing, which also serves as collateral for the mortgage itself. Double duty for the win!
Master Promissory Note
A Master Promissory Note (MPN) is the same as a promissory note – it’s a legally binding document that obligates a borrower to repay a loan and abide by the terms of the agreement. The “master” in front comes from the fact that lenders and borrowers can use a master promissory note across multiple loans, like in the case of federal student loans. (Most often, you will see the MPN terminology used in conjunction with federal student loans.)
A new promissory note must be issued for every new loan. For example, if you ever refinanced a home, you’d sign a new promissory note because a refinanced loan is a new loan. When students take out new loans for a new school year with their lender, they use the same MPN, thus eliminating the need for signing a new promissory note each time.
The Bottom Line
A promissory note is a key piece of a home loan application and mortgage agreement, ensuring that a borrower agrees to be indebted to a lender for loan repayment. Ultimately, it serves as a necessary piece of the legal puzzle that helps guarantee that sums are repaid in full and in a timely fashion.
A promissory note is something a homeowner will see and need to sign at closing, but first, you’ll need to apply for a mortgage. Need more help with complex real estate terminology? Browse the Rocket Mortgage Learning Center for more articles.
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