What's the Difference Between a Promissory Note vs. a Mortgage?
Updated: Mar 8
Although it's common for individuals to acquire loans to acquire a house during a real estate transaction, many are not aware of the distinction between promissory notes and mortgages. This article will explain each of their characteristics and why understanding this knowledge is crucial.
Also referred to as a mortgage note, a promissory note is a document that states one party's commitment to pay an agreed-upon amount of money to another party.
Owner financing between private entities and borrowers is secured when promissory notes are used, as they ensure that payments are made directly to the seller when banks or traditional lenders aren't involved.
The agreement in the note allows the mortgage lender to exercise their legal rights by way of lien, foreclosure, or eviction.
More About Mortgages
Obtaining a mortgage from a mortgage company or a title company is taking out a loan backed by real estate, which the mortgage lender has the legal right to take over should the borrower stop paying.
Given that many people lack enough money to buy a home outright, the National Association of Home Builders determined that in 2022, approximately 69% of US households — 87.5 million total — couldn't afford the median-priced home.
With owner financing, the buyer pays the property owner to gain full ownership of it, with the property owner acting as the lender.
When getting a traditional mortgage loan for buying a home, lenders usually require you to sign both a mortgage and promissory note or related legal agreement.
A promissory note outlines that you'll be making monthly payments to reimburse the mortgage loan payments taken. On the other hand, a mortgage is set up to provide the lender. In general, a promissory note is essentially a form of an IOU.
You and the purchased house will undergo a verification process if you decide to get a mortgage. The prospective mortgage lender will assess your creditworthiness and the value of the house to make sure it's enough to cover the loan if there's ever a default situation.
A mortgage note outlines the details and loan terms of your loan, like how you'll repay it and that your home will be used as collateral when you go through the homebuying process.
Again a "promissory note" is essentially a signed contract between a lender and borrower where the borrower agrees to repay whatever funds they're borrowing from the lender. Essentially, it's an IOU and only those who sign the promissory note are responsible for repaying the amount borrowed.
The promissory note states that the borrower must repay the loan, and outlines the terms of repayment. For example, typically a note will explain:
The full loan amount;
The rate of interest;
The borrower must give the lender a set amount each period (usually monthly);
The penalty fee for any overdue payments, and;
How much time does the borrower have to repay the loan?
After you've paid off the loan with regular payments via the necessary payments (which take a long time), the lender marks your promissory note as "paid in full"
Mortgages: The Power to Take Away Your Home
A promissory note is your assurance that you'll pay back the loan while a mortgage or deed of trust (depending on the state) will say what happens if you default.
With mortgages, the title to the home is used as collateral for the loan. If payments are not made on time, the lender can reclaim ownership of the house and you could face legal issues.
When taking on a mortgage, you must understand what the agreement entails. Normally this includes:
Maintain the home's condition.
Avoid having any hazardous substances on the premises.
Make sure to get homeowners' insurance for the property.
Make the property tax payments. In the case of a potential foreclosure sale, lenders want borrowers to handle their responsibilities so the house will make more money at a foreclosure sale. This is because an unstained property that's in good condition is worth more than one left in disrepair with liens.
Furthermore, some creditors may require collections to cover homeowners' insurance costs (and maybe other expenses).
If you are unsure what you are getting yourself into when it comes to a home loan, you should talk to a real estate attorney who has extensive experience before you sign anything. It is also wise to consult a foreclosure attorney if there is a chance of facing foreclosure. Someone with the proper experience be it a real estate agent or real estate attorney should have knowledge of the various types of deeds, be able to offer legal advice, and know the difference between a note and vs mortgage.