If you’re planning to purchase a home, it’s essential to understand the distinction between a promissory note and a mortgage.
The promissory note is a legally binding document that serves as a “promise” to repay the funds that the lender provides to purchase the property.
On the other hand, the mortgage is a legal agreement that secures the note to the property itself. If the borrower cannot repay the loan, the lender can use the property to recover the funds owed.
How Are Promissory Notes and Mortgages Different?
Bankers and lenders use various terms such as note, mortgage, security, and other phrases during the sale of a house, which can be confusing for an average buyer. Understanding the difference between a mortgage and a promissory note is essential. Is there any difference?
There are some significant differences, and a smart home buyer must learn them quickly before putting any signatures on their documents. When you buy a home, you get a loan from the bank, and the bank needs some collateral for the loan.
Mortgage: The mortgage provides security for the loan. A deed of trust security deed is used in some states. Until the loan is paid off, the bank or other lending agency owns an interest in the property.
Promissory Note: Is the actual loan document. It is essentially a formal IOU. The note contains the loan payment terms, who is responsible for paying, and how the loan can be collected.
| Mortgage | Promissory Note | |
|---|---|---|
| Purpose | Provides collateral for the loan | Borrower’s written promise to repay debt |
| Contents | Homeowners’ duties Legal description of property Covenants between homeowner and lender | Loan terms, interest rates, late charges, duration |
| Legal Implications | Creates lien on property Gives lender right to foreclose | Gives the lender the right to collect on the loan if the borrower misses payments |
| Holder | Recorded with county | Not recorded Lender holds note until after repayment |
Purpose of Promissory Note vs Mortgage
- The purpose of a promissory note is to create a legally binding agreement between the borrower and the lender, outlining the borrower’s promise to repay the debt and ensuring that the lender receives the funds they are owed.
- The purpose of a mortgage is to create a lien on the property, which acts as collateral for the loan. This gives the lender some security if the borrower cannot repay the loan.
Contents of Promissory Note vs Mortgage
- A promissory note includes essential details such as the date, parties involved, principal amount, interest rate, repayment terms, late fees, prepayment penalty, collateral, governing law, and signatures of the borrower and the lender.
- A mortgage typically contains information about the mortgaged property, loan terms and repayment details, payment schedule, escrow information, borrower responsibilities, and lender rights. It’s important to carefully review and understand the contents of a mortgage before signing.
Legal Implications of Promissory Note vs Mortgage
- The promissory note creates a personal relationship between the lender and the borrower. The lender can sue the borrower personally if any payments are missed.
- The mortgage puts a lien on the property. If the borrower defaults, the lender can foreclose on the property and get a deficiency judgment against the borrower.
When you take out a loan, the lender will hold onto the note until you have paid back the entire amount. Initially, the lender will also hold onto the mortgage, but it’s common for them to sell it later.
The mortgage is always linked to the property, meaning it will permanently be attached. On the other hand, the promissory note is attached to the borrower, and it’s not recorded. This means that you, as the borrower, are always responsible for paying back the note.
Signing a Note vs Mortgage
- When buying a home, you must sign a mortgage. However, you may not need to sign a promissory note. This is signed by the person responsible for paying back the loan, whereas the person or persons on the deed sign the mortgage.
For example, if a married couple takes out a home loan and plans to own the property jointly, both will appear on the deed and sign the mortgage. However, if only one spouse qualifies for the loan, only that spouse will sign the note.
It’s important for couples to remember that the mortgage follows the property, but the note follows the signer. If the couple gets divorced before the mortgage is paid off, one spouse could find themselves solely responsible for the entire loan, even if they divided the property equally with their former partner.
Legal and Practical Considerations
State laws differ in how they handle mortgage foreclosure and enforcement. Several state laws have been passed to protect borrowers from predatory lending practices since the 2008 housing crisis. Always consult with a lawyer before signing a mortgage or promissory note.
Mortgage Redemption:
- Some states allow borrowers to repay overdue amounts during foreclosure (redemption).
- Deadlines for redemption vary by state (before, during, or after foreclosure sale).
- If facing foreclosure, see an attorney immediately, as the redemption window is narrow.
Predatory Lending Protections:
- Some states ban loan flipping (refinancing loans repeatedly to generate lender fees).
- Negative amortization (increasing loan balance due to insufficient payments) may also be illegal.
Dual Tracking:
- Dual tracking happens when a lender pursues foreclosure while negotiating a loan modification.
- Some states have laws prohibiting foreclosure while a loan modification or similar process is ongoing.
Consult an attorney throughout the home buying process, including purchase, loan application, and refinancing. Legal advice is important due to frequent changes in state laws and the dynamic nature of the housing market.
Why Both are Important in Real Estate Transactions
The promissory note and mortgage work together to secure real estate loans. The mortgage provides collateral when home buyers otherwise would not be able to buy property. The note ensures that lenders have recourse against buyers even when property values drop in uncertain markets.
When the loan is repaid in full, the lender records a release of mortgage or satisfaction of mortgage in the county records. This removes the lien, and the homeowners own the property free and clear. The promissory note is marked paid in full and returned to the borrower.
Frequently Asked Questions
Can a promissory note be used without a mortgage?
Yes, and often is. Promissory notes are often used for any unsecured loan. A promissory note is used whenever someone needs a guarantee that a loan will be repaid.
Can a mortgage be used without a promissory note?
Depending on how the mortgage is secured, a promissory note may not be required. For example, borrowing from a family member may not require one. However, obtaining a bank loan typically requires signing a promissory note.
How are mortgages and promissory notes related?
The two documents create a legally binding financial relationship between the borrower and the lender when selling the property. If the borrower defaults on the loan and cannot pay for other reasons, the mortgage provides another means by which the lender can be repaid.
What happens if I sign the mortgage but not the promissory note?
When you take out a mortgage, the lender can foreclose on your property if you don’t make the payments. However, if you signed only the mortgage and not the promissory note, you can walk away from the property without fear of legal action.
For example, a husband and wife bought a house, and both signed the mortgage. However, only the husband signed the note. After ten years, they divorced, and the wife moved out of state, leaving the husband with the mortgage and note. If the husband can’t pay the loan, the bank can either foreclose (since both spouses gave permission with the mortgage) or sue the husband (since he signed the note), but they can’t take legal action against the wife.
