Promissory notes are documents that represent a promise to pay back loans. There are several different types of promissory notes that are used for different situations. Any type of a promissory note may contain a variety of terms and conditions. Before entering into any such agreement, it's important that you understand the terms.
Is a Promissory Note the Same as a Mortgage?
Before we explore the various types of promissory notes, it's worth pointing out that mortgages and promissory notes are not the same things. When you borrow money to purchase real estate, you must sign both a mortgage and a promissory note.
The promissory note is the actual promise to repay the loan. It contains all of the basic information about the borrower, as well as the amount of the loan, interest and terms. This document is usually held by the lender and is not recorded in county land records.
The Mortgage, also known as a deed of trust, is a security agreement that describes the terms ensuring that the promissory note is honored. If the promissory note is not paid, the borrower forecloses and relinquishes ownership of the property. The purpose of the mortgage is to protect the investment of the lender in case the borrower defaults on the loan.
Common Types of Promissory Notes
There are different types of promissory notes based on the lending situation and parties involved.
- Personal: These are notes signed by friends, family members or acquaintances that promise repayment of a loan. Such documents can appear informal, but they are still legally binding. For example, a signed promissory note written on a paper napkin and signed by both parties can still be used in court to demonstrate the existence of a loan and a promise of repayment.
- Commercial: Any type of a promissory note that involves a commercial lender, such as a bank. Commercial promissory notes are more formal and contain more detailed and stringent conditions than personal ones.
- Real Estate: These are notes associated with real estate transactions. As discussed above, they are usually backed by a mortgage. Real estate promissory notes can also be commercial ones, as they typically involve banks or other commercial money lenders. However, in some cases they may simply be agreements between the buyer and seller.
- Investments: Promissory notes created for the purpose of raising capital. The terms usually involve repayment based on future returns on the investment. This type of promissory note carries higher than average risk to the lender, as there is never a guarantee when it comes to how an investment will perform.