A note in real estate is a promise to pay a loan. Your lender will make you sign one together with a mortgage that attaches a lien against the property securing your promise. It specifies the terms of your loan, including:
- The total amount of the loan
- Interest rate
- Monthly payment amount
- Amount of late charge fees
- Repayment period
It is your IOU to the bank, and it sets the terms of the loan.
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Difference Between a Mortgage and a Note in Real Estate
There is a difference between a note and a mortgage, but the two go together. When you buy a house, the bank makes you sign both. Together they set up the terms of the loan and make sure the lender gets paid.
- The buyer must sign a promissory note that they will repay the loan.
- Your lender records the mortgage with the township thereby attaching a lien on the property to secure the loan.
The note is just a promise to pay, but the mortgage gives the bank a way to recover their money, by foreclosing, if you don’t pay back your loan.1
Who Keeps the Original Promissory Note in Real Estate?
Your lender keeps the original promissory note. While you pay your loan, this instrument may move around, but it stays with whoever services your debt.
- Once you sign the paperwork your lender files your note and records your mortgage
- The bank may sell your note at some point and then that institution keeps it
- Once you pay off your loan the bank marks it paid in full and gives it to you
Banks buy and sell loans regularly. When this happens, the lender records an assignment with the local government. The note is endorsed (signed over) to the new owner. Sometimes the bank endorses it in blank. This means that anyone who processes the loan may enforce it.2
How do I Find My Mortgage Note?
Your lender keeps your original promissory note and gives you a copy at closing. So, the place to start looking is in your closing documents. You should find a copy there. If you don’t, there are several other places to go find it:
- Your lender has the original and will give you a copy
- If you used a mortgage broker, they have a copy
- Your attorney or title company keeps a copy in their records
- Your local government’s land department keeps a copy of it with the mortgage
The best thing to do is to keep your closing documents together in a safe place. These are important legal papers and you should protect them. We recommend putting them in a secure filing cabinet or safe together with other important documents such as birth and marriage certificates, passports and other loan documents (like car loans).3
What Does it Mean to Hold a Note in Real Estate?
Generally, when you hold a note in real estate you finance the sale of your house yourself. It is one way you can diversify your investments and generate an income stream. This strategy has advantages and disadvantages for both parties. For the seller:
- It generates a monthly income stream
- Potentially a higher profit on the sale
- Rights to the property in case of non-payment
- In the case of non-payment, the foreclosure process is long and complicated
- The property ties up equity that you could invest somewhere else
For the buyers, pros and cons include:
- Generally, there are fewer issues, and they can close faster
- They may avoid PMI
- More costs are negotiable than with banks
- Usually, people holding a note charge a higher interest rate than a bank
The two biggest issues that sellers usually have are tying up their equity and keeping up with the loan. Tying up that much money in one place is a big deal for most people, so only do this if you have enough capital to diversify this way. Also, only do this if you have the diligence to keep track of the house and the loan. It is a lot of work, and not for everyone. Finally, hire a good attorney to help you draw up the documents and file the paperwork in the appropriate places.4
Carry a Note on a House
How you carry a note is that you take on the role of the lender. The process is like a traditional transaction with the seller extending credit instead of the bank. The parties sign a promissory note. Then, the seller records the mortgage. Finally, the buyer pays back the loan over time.
These loans are often short term because sellers usually don’t want to tie up equity for an extended period and/or the buyer’s financial situation improves enough to get a traditional mortgage.
A seller is in the best position to offer this solution if they don’t have a mortgage on the house themselves. If the seller still has a mortgage, then their bank must approve the transaction. However, most lenders aren’t willing to take on that extra risk.
If you do want to finance your house sale yourself, you need to decide the structure of the loan. Here are some common models that people use:
- All-inclusive – You carry the entire purchase price in the loan.
- Junior – You carry the down payment for the seller if they don’t have enough.
- Land contract – you don’t pass title to the property until after the loan is paid.
- Lease option – You give the renter an option to buy the property under certain conditions.
- Assumable mortgage – You agree to the buyer taking over the payments on your existing mortgage. The bank must agree to this.
Do not do this without seeking professional legal help. This is a complicated transaction, and even if you are a savvy professional with property transaction experience you should get help making sure you do everything properly.5
Final Thoughts
While notes in real estate are tied to mortgages, they are distinct legal documents. They are the promise to pay back your loan, but they don’t carry any method for the lender to recoup losses for non-payment. In a sense, they have a life of their own, because investors buy and sell them regularly. In fact. There is a huge market for all kinds of debt obligations, of which mortgage notes are just one type.
If you consider holding the note on your house and loaning money to a potential buyer make sure you understand your reasons Also make sure you know why the buyer wants to borrow funds this way. Seek legal help before making your decision.
