What is a promissory note? The document that shapes your mortgage journey

If a mortgage loan were an apple, the promissory note would be its core. This formal document helps hold the loan together.

A promissory note is a written promise that you'll repay the loan according to its terms. Without this note, the lender couldn't pay out the hundreds of thousands of dollars, or more, you need to buy a home.

Despite its importance, many borrowers still wonder, "What is a promissory note?" So let's take a closer look.

What is a promissory note?

A promissory note is a legally binding financial document. In the note, one party promises to pay a specific amount to another party.

On a promissory note for a mortgage loan, the borrower agrees to repay the lender. For a 30-year mortgage, the borrower agrees to make all the regular monthly payments required until the loan balance reaches $0.

If the borrower fails to keep the loan agreement as defined by the promissory note, the note, combined with the deed of trust, will also define next steps.

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Secured vs unsecured promissory notes

Promissory notes can be secured or unsecured. A secured note creates tangible consequences if the buyer fails to keep the loan agreement that was signed at the loan's closing. This creates more security for the lender. For home buyers, that consequence is potentially losing the home through foreclosure.

In other words, the home serves as collateral for the loan. This security makes mortgage loans viable for lenders. Collateral gives them a way to recover lost money if the borrower fails to repay the loan.

Unsecured promissory notes don't include collateral. Credit cards and personal loans usually follow this loan agreement model. The lender can report the borrower's failure to repay the loan to the credit bureaus, harming the borrower's credit score, but the lender has no tangible way to recover money lost from the loan.

How does a promissory note work in real estate?

The promissory note details how a mortgage loan works. After both parties, the lender and the borrower, sign the note during the closing process, the mortgage deed of trust establishes the home as collateral on the loan. 

Then, the lender holds the promissory note until the borrower pays off the full balance of the mortgage, either by making all the monthly payments on time or by paying off the full balance in one lump sum payment. A lump sum payment usually happens only when the homeowner sells or refinances the loan.

When the borrower pays off the loan, the lender will send back the original copy of the promissory note and release the deed of trust on the home. This formally ends the partnership between lender and borrower on the home. 

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What is on a promissory note?

The relationship between a borrower and a lender, which is defined by the real estate promissory note, is typically long and important. It's smart to understand everything about the promissory note, which should include:

• Names and addresses of you and your lender
• Principal amount borrowed (your total loan sum)
• Interest rate and terms including how interest gets calculated
• Payment schedule detailing when payments are due and minimum amounts
• Loan term specifying your repayment timeframe (30 years for most borrowers)
• Late payment penalties explaining consequences for missed or late payments
• Default clause defining when a loan is considered in default
• Acceleration clause allowing your lender to demand full payment if terms are violated
• Collection costs outlining your responsibility for legal expenses incurred by the lender
• Assignment clause allowing your lender to sell or transfer the loan

The promissory note may also require the borrower to keep the home insured and to keep property taxes up to date.

The costs required by the promissory note will also be spelled out clearly in the Closing Disclosure.

Types of promissory notes

Promissory notes define the terms for all types of lending. The most common notes include: 

Installment notes

This is the most common type of promissory note in mortgage lending. Installment notes set a fixed schedule for repaying both principal and interest over time through regular monthly payments. A typical 30-year mortgage follows this structure, breaking down the debt into payments.

Open-ended notes

These notes create lines of credit, allowing you to borrow up to a preset credit limit. As you repay funds, that amount becomes available to borrow again. Home equity lines of credit (HELOCs) often use this structure, giving homeowners flexibility to access their equity as needed.

Simple notes

Simple promissory notes require borrowers to repay the entire loan amount in one lump sum payment. These are used for short-term loans like bridge loans or temporary construction loans which are designed to be refinanced into longer-term loans. 

Demand notes

These loan agreements give lenders the right to request full repayment at any time, creating more security for the lender. While not common in mortgages, you might encounter these in non-QM or investment lending situations.

Pros and cons of a promissory note

Promissory notes make mortgage borrowing possible. That's a big pro, one that will outweigh any cons of the note for most borrowers.

Other advantages of promissory notes include:

• Legal enforceability: A promissory note defines the relationship between borrower and lender in legal terms that are enforceable and clear. - Clarity: Promissory notes spell out all loan conditions, eliminating confusion about your repayment responsibilities. As the borrower, you'll know exactly what the loan costs over time and when payments are due, preventing disputes about payment schedules.
• Flexibility: Because of the promissory note and deed of trust, the borrower can own the home and control what happens to it (within the terms of the note) even when the lender has paid for the majority of the home. 
• Savings: Because of the security promissory notes and deeds of trust create for the lender, interest rates for secured loans tend to be lower than rates on unsecured debt.
  Many homeowners forget all about their promissory note once it's signed. As long as they repay the loan as agreed, the note can seem like a formality. That said, it's smart to keep a copy of the promissory note for quick reference.

Promissory note FAQs

Can I write my own promissory note?

You can write a promissory note yourself, but self-created documents may not withstand legal challenges in court. If you're entering an owner-financing agreement or a rent-to-own loan agreement, work with an attorney to make sure your document meets state and federal regulations. 

Can I have a promissory note without a mortgage?

Promissory notes define loan terms for everything from corporate borrowing to student loans to informal personal loans between family members. Whenever someone borrows money, a promissory note can formalize the loan agreement. Non-mortgage notes follow the same basic structure but typically don't require property as collateral.

What happens once my promissory note is fully paid off?

When you complete all payments on a mortgage loan, lenders will typically mark the original note as "paid in full" or "cancelled" and return it to you. The return of this document proves your obligation to the lender has ended. No further payments are required, and any collateral securing the loan gets released back to you.

Promissory notes provide transparency for home buyers

Promissory notes may seem technical and boring, but they're also important. They set the terms of a mortgage loan used to buy your home.

Home buyers should understand how the promissory note works before they sign it. If you don't understand something about your promissory note, be sure to ask your loan officer.

Transparent lenders will welcome questions about all documents you sign as well as questions about other parts of the borrowing journey, a journey that begins with a mortgage pre-approval.

Better's pre-approval requires only a soft credit check and creates no obligation. 

...in as little as 3 minutes – no credit impact