Promissory Notes, Defined And Explained
Scott Steinberg5-minute read
December 04, 2020
A promissory note is a written repayment agreement between a borrower and a financial lender that constitutes a promise by the borrower to pay back any sums lent to them. Anyone who wishes to lend money can issue one, not just a bank, credit union, or financial technology provider, and the promissory note will contain terms of the agreement between each party. In the context of home mortgages though, it is important to note that while a promissory note is not a contract and differs from a home loan, you will still be asked to sign one prior to formalizing a mortgage application.
What Is A Promissory Note?
Promissory notes are legal documents executed between borrowers (i.e. an everyday individual who is applying for a mortgage such as yourself) and financial lenders (e.g. a bank, credit union, mortgage company, or online financial technology provider). Within them, you’ll find information on the lender, the borrower, and the terms of the loan agreement to which each will be bound. Common items contained within a promissory note include information pertaining to:
- 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
In effect, a mortgage promissory note serves an agreement in which the borrower promises to pay back all sums lent by the lender. A legally binding IOU note of sorts, before its provisions come into effect, the promissory note must be executed and signed by the borrower.
Note that 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 a home, condominium, or rental property as collateral to ensure that sums are repaid. An unsecured promissory note does not come with these up-front requirements, though you are still obligated to repay it.
IOUs And Loan Contracts Vs. Promissory Notes
IOUs are often informal reminders that money is owed by one party to another. Promissory notes instead contain a legally-binding promise to pay any debts that are undertaken. Loan contracts are also legally binding, and provide a detailed rundown of sums borrowed, repayment terms, and how any defaults or breaches of said loan terms (e.g. late or missing payments) will be addressed.
Master Promissory Notes
A Master Promissory Note (MPN) is a legally binding document that obligates you to repay a loan and abide by the terms of the agreement. For example, in the case of federal student loans, you can expect to execute a master promissory note with the US government that establishes that you will adhere to the loan’s formal conditions and guidelines. Upon signing one, you effectively agree to pay back not just the loan principal, but also any additional interest charges, fees and penalties that are incurred across the life of the loan as well.
Promissory Notes And Mortgages
As part of the home loan mortgage process, you can expect to execute both a legally binding mortgage and mortgage promissory note, which work towards 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. Signing a promissory note cements that you will be indebted to the lender for the loan and mortgage note that they have extended. (In which you can often find a more detailed description of specific actions that will happen if you are late or default on payments, i.e. how the foreclosure process might work.)
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 promissory note with the remainder of your closing documents when you close upon a property to boot.
Deeds Of Trust Vs. Promissory Notes
A deed of trust is an agreement that’s issued at the time of closing on a property between a lender and home buyer. This document reiterates that the home buyer will repay the loan, and mortgage lender will hold legal title to the property until the loan is paid in full by the borrower.
In exchange for this deed of trust, the borrower must execute one or more promissory notes, which are given to the lender. The promissory note extends a promise from the borrower to the lender to repay this debt, and details select terms of the loan.
This promissory note is held by the lender until the buyer ultimately pays off the home, though the buyer will receive a copy of the document for their records. After the loan is fully paid off, the promissory note will be marked “paid in full,” and the deed will be returned to the home buyer.
A take-back mortgage effectively allows a home seller to become a lender who can loan a buyer money to purchase a home that they are selling. This home must be owned outright by the seller (not currently under monthly mortgage).
The buyer (aka the borrower) is required to make regular payments to the seller, as under a standard home loan, though typically at higher interest rate terms than under a traditional mortgage agreement.
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 that 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.
Elements Of A Promissory Note
You can expect to find several common elements contained within 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 one 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
A Promise For Your Mortgage
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 timely fashion. To find out more about the best mortgage options available to you as a borrower, and how to streamline and simplify the loan repayment process, you can read more key about mortgage terms and details today.
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