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- A promissory note is a mortgage document promising to pay back a lender under certain terms.
- The note includes information such as how much you're borrowing and the mortgage interest rate.
- The lender keeps your promissory note until you pay off the mortgage, but you can request a copy.
When you buy a home, you'll have to read and sign a lot of documents. An important one is the promissory note, which explains the terms of your home loan.
What is a promissory note?
During the homebuying process, your mortgage lender will have you sign a promissory note. Here's what you need to know about this document:
Definition
What's a promissory note? It's a written legal document you'll sign to promise you will repay the company what it lends you to buy your home.
The lender holds onto the promissory note while you pay off your mortgage, but you can request a copy. Once you've made the final payment, the company will mark your original note as paid and return it to you.
Purpose
A promissory note formalizes a loan agreement. In the mortgage world, it explains the terms of your mortgage loan, including how much you're borrowing and the interest rate, term length, and monthly payment schedule. It also serves as evidence of your debt until the loan has been paid off.
Legal standing
Promissory notes are legally binding contracts. If you fail to repay your loan, the lender can enforce the document in court, resulting in the loss of your home.
Key elements of a promissory note
Here's what you can expect to find in a promissory note:
Identification of parties
A promissory note will always clearly identify the names of both the borrower (or borrowers) and the lender in the transaction, as well as their contact information.
Principal amount
You'll also see your mortgage principal, or the amount you borrow for your mortgage. If you borrow $200,000 to buy your home, your principal is $200,000.
Interest rate
The mortgage interest rate, or the fee the lender charges for lending you money, will also be listed on the promissory note. Interest will be expressed as a percentage, such as 6.85% or 7.15%.
Repayment terms
The note will also include the repayment term of the loan, or the amount of time you'll spend paying back your mortgage, such as 30 or 15 years.
There should also be a payment schedule detailing the frequency and amounts of your mortgage payments.
Signatures
You and the lender will both need to sign and date the promissory note to make it legally binding.
Types of promissory notes
There are several types of promissory notes. These include:
Secured vs. unsecured promissory notes
Secured promissory notes are backed by collateral, like a car or house. The lender can seize this collateral if the borrower defaults on the loan. Unsecured promissory notes, on the other hand, are not backed by collateral.
Demand vs. installment promissory notes
Demand promissory notes are payable in full upon the lender's demand. With an installment promissory note, you'll pay the money back in regular installments over time.
Other types of promissory notes
There are also other types of promissory notes, including commercial, convertible, and real estate promissory notes. Balloon promissory notes are a possibility, too. These allow for smaller installment payments for a period of time but then require a large balloon payment at the end of the loan term.
Why use a promissory note?
There are many reasons to use a promissory note. For example, they:
Protect both parties
A promissory note provides a clear record of the loan agreement, protecting both the borrower's and lender's interests in case of a future dispute.
Provides legal recourse
A promissory note is a legally enforceable document. It gives the lender recourse in case a borrower fails to make payments.
Tax and accounting purposes
Promissory notes can also be relevant for tax and accounting purposes, both for lenders and for borrowers. You can use one to determine how much you're paying each year toward the loan and other important details.
How to write a promissory note
You may want to use a promissory note for a transaction you're planning. Here's how to do that:
Templates and legal assistance
The easiest option is to use an online promissory note template. If you want to be sure the document provides the best protection and is legally binding, though, your best bet is to go through a legal professional. They can draw up the document on your behalf and ensure it meets all promissory note legal requirements.
Clarity and specificity
A promissory note needs to be clear, specific, and detailed, so that there are no misunderstandings as to what both parties are agreeing to. Again, consulting a legal pro is best here.
Promissory note FAQs
Promissory notes and loan contracts serve similar purposes, but a loan contract is typically more detailed and comprehensive. A promissory note is a simpler legal document outlining the basics of an agreement.
If you have a promissory note and fail to make payments as agreed upon, the lender can take legal action to enforce its terms. This includes suing for the outstanding balance and potentially seeking collection of collateral if it's a secured note. (i.e., foreclosure).
A promissory note can be changed after signing as long as both parties agree to modify the terms. Keep in mind that changes should be made in writing and signed (again) by both parties.
