The Difference Between Mortgages & Promissory Notes

If you’re not in real estate, learning the difference between a mortgage vs. promissory note can get complicated and convoluted. They both are important documents that you’ll sign when you buy a home. However, while these documents are both meant to ensure that the lender gets repaid, there are some major differences between the two.

Put simply, a mortgage is a legal document stating that a real estate property has been used as collateral to secure a loan. If the borrower is unable to repay the loan, the mortgage gives the lender the right to foreclose on the property that’s the collateral for the loan. While any loan can be secured with a traditional mortgage, this article will focus on explaining mortgages in the context of a home mortgage loan.

Meanwhile, a promissory note is a promise to repay the loan. Promissory notes are legally binding, just like mortgage documents.

What’s the Difference Between a Mortgage vs Promissory Note in Real Estate?

With that said, we’ll take a closer look at each of these two instruments below. With this knowledge, you’ll better understand the role that they play in real estate transactions.

Key Takeaways

By the end of this article, you will know that:

A promissory note is essentially an IOU, a legally binding promise to pay a loan. A promissory note may also be a mortgage note, but not all promissory notes are mortgage notes.
A mortgage is a legal document that describes the collateral on the loan, and what happens if the loan isn’t repaid according to the terms set out. In some states, the equivalent of a mortgage deed is a deed of trust.
Whereas the promissory note can be bought and sold in the secondary market, the mortgage deed can’t be bought and sold on the secondary market. Promissory notes, and not mortgage deeds, are bought and sold on the secondary market. Mortgage deeds are kept as part of publicly available records, but promissory notes generally are not.
You can sell a property with just a promissory note, but it’s usually advisable to have both that and a mortgage deed.

Promissory Note Explained

When a person takes out a loan, the lender may require the borrower to formalize the loan by signing a promissory note. The promissory note is a document that serves as evidence of the promise of the borrower to repay the loan. A loan formalized with a promissory note may be secured by real property or unsecured. If it’s an unsecured loan, then the does not give the lender the right to sell the collateral to get the balance of the loan if the borrower defaults.

In layman’s terms, it can be helpful to think about a promissory note as an IOU, which is the short form of “I owe you.” It’s basically that—an acknowledgement of a debt and a promise to repay.

Notably, while a bank can certainly issue a promissory note, so can an individual or private company. Truthfully, anyone who is lending money has the power to do so.

Terms of the Promissory Note

Typically, a promissory note will also contain details about the loan and its repayment terms. Generally, you can expect the following terms to be included in it:

The lender: The person or entity lending the money.
The borrower: The person or persons responsible for repaying the debt.
The contract origination date: The date on which the agreement was signed and becomes effective.
The principal loan amount: The amount of money that’s being borrowed by the payer.
The interest rate: The amount you have to pay for the privilege of borrowing money. It’s typically expressed as a percentage, in annual terms, of the total amount owed.
The date of your first payment: The day when your first regular payment on the loan is due.
The maturity date: The date that the loan will be paid off in full if all the payments are made on time.

The payee holds onto the promissory note until the loan is repaid in full. When that happens, usually after many years, the note is marked as such and given back to the payor, who then has full control over the property they bought.

Like we mentioned earlier, a promissory note can be sold on the secondary market. This is done through a process called assignment or endorsement, where the original holder transfers their rights to another investor or institution. The seller typically discounts the note’s value to make it attractive to buyers, considering factors like the creditworthiness of the borrower, remaining term, and prevailing interest rates.

Once the potential seller and the potential buyer reach an agreement, they formalize it through a written assignment, and the new holder assumes the right to collect payments. Some notes are securitized and bundled with others to be sold as investment instruments. Common buyers in the secondary market are financial institutions, private investors, and hedge funds. These seek returns through interest payments or potential resale at a premium.

Promissory Note FAQs

Without a mortgage, a promissory note is essentially a promise to repay a loan without real estate financing. Unlike a mortgagee, the ordinary payee of a promissory note doesn’t enjoy the protection of having a claim property until the loan is repaid.

Promissory notes are often regarded as assets of the lender after his death. This means that just like other assets owned by the lender, the promissory note will pass to the administrator or executor of the lender’s estate. This person can choose to enforce the promissory note by ensuring that the borrower pays the amount promised. They may also sell it to a mortgage note buyer.

Typically, the borrower undertakes to repay the loan, either at once or in instalments. Whichever the case is, the borrower always promises to repay all of the amount loaned in its entirety. This amount is stated in the terms of a loan. It therefore means that it’s the terms of a loan that determine the monetary worth of a promissory note.

An unsigned promissory note can’t be enforced against the borrower. A signed mortgage can very well be enforced, though. The existence of the mortgage creates a situation where the lender is entitled to sell the property to recover the debt if the borrower defaults.

Like a loan note, a promissory note is a legal document containing an acknowledgement of debt. However, while the promissory note serves more informal lending scenarios, the loan note is an IOU issued by a company to an investor.

The opposite of a promissory note is a bill of exchange. While a promissory note is a written promise by one party to pay a specific amount to another, a bill of exchange is an order from one party (the drawer) instructing another party (the drawee) to pay a third party (the payee). In a promissory note, the issuer is directly liable for payment, whereas, in a bill of exchange, the drawee (often a bank or another party) is responsible for making the payment upon acceptance.

The original promissory note can be used in a variety of transactions. Examples of promissory notes include student loan promissory notes (which contain repayment terms for educational loans) and real estate promissory notes (which are used for property financing).

A promissory note outlines the terms of a personal loan. It’s not a loan in itself.

The borrower must sign a promissory note. In cases where the borrower isn’t the one responsible for the repayment of the loan under the agreement, then whoever is responsible for repaying the loan must sign the note.

A promissory note is endorsed by the current holder or payee when transferring it to another party. This endorsement, usually done by signing the back of the note or attaching an alonge, legally transfers the right to collect payment to the new holder. In some cases, a single note can be endorsed multiple times if it changes hands multiple times in the secondary market.

Yes, you can transfer a promissory note. Transferring a promissory note means handing it over to a new payee who’ll be entitled to the loan repaid by the payer.

A guarantor can guarantee a promissory note. The purpose of guaranteeing a promise note is to ensure that if the person who’s primarily responsible for repaying the loan defaults, the lender can demand payment from a third party.

If a promissory note is lost, the lender must prove its existence and terms to enforce repayment. This often involves providing copies, witness testimony, or other supporting documents. Courts may issue a replacement note or require the borrower to sign a new one. In some cases, the lender may need to file a legal claim to recover the debt.

Yes, a promissory note can be canceled if the debt is fully repaid, the lender forgives the loan, or both parties agree to void the agreement. The lender should provide a written release of obligation or mark the note as “paid in full” to avoid future disputes.

Here are some reasons why you might have a promissory note but wish you didn’t:

Lack of security: Unlike secured loans, many promissory notes are unsecured, increasing the lender’s risk. As a lender, it’s a good idea to insist on not accepting unsecured promissory notes. Demand for some form of collateral to secure the note. While the arrangement still won’t be like a mortgage loan, you’ll at least have a bit of protection.
Limited legal protection: If the borrower defaults, enforcing repayment may require legal action. Without a mortgage, you can’t directly sell the collateral to get the balance of the loan.
Interest rate risks: Notes with fixed interest rates may become unfavorable if market rates change.
Transferability issues: Some promissory notes have restrictions on being sold or assigned to another party.

Meanwhile, a mortgage — which is sometimes referred to as a mortgage deed — describes the property collateral and what happens if you do not hold up your end of the bargain and keep making payments on your loan.

However, it’s important to note that not all states use mortgage deeds. In fact, some states use a document called a “deed of trust” to give lenders recourse over the property if a borrower defaults on the loan. For the purposes of this article, though, all you need to know is that those two documents essentially serve the same purpose.

Typically, in a traditional lending scenario, the mortgage gives the lender the right to accelerate repayment of the loan, or ask to be repaid in full, if the borrower is not diligent in making their installment payments. When this happens, if the borrower doesn’t pay what is requested, the lender has the option to foreclose on the home or to sell it to try to recoup some of their losses.

In addition, your mortgage deed will more than likely lay out some responsibilities that the lender requires you to fulfill. Generally, homeowners are required to keep the property in good condition, to pay their taxes, and to maintain an up-to-date homeowner’s insurance policy. This is all meant to ensure that while the mortgage deed gives the lender the right to foreclose on your home, it also protects them from having to contend with expensive liens or repairs, which might cause further losses.

It’s important to keep in mind that while the mortgage deed outlines the amount loaned and the interest rate, the loan contract is separate from the mortgage agreement. This means that if the mortgaged property is destroyed, the borrower isn’t relieved of their debt because the loan contract is, in the eyes of the law, standing on its own. The mortgage agreement simply supports the loan contract. If the mortgaged property is destroyed, the destruction of the property doesn’t affect the validity of the loan contract.

Information in a mortgage

The key information typically included in a mortgage includes:

Identification of parties: The names and contact details of the borrower (mortgagor) and the lender (mortgagee).
Property description: A detailed description of the property being mortgaged, including its address and legal description, to clearly identify the property being used as collateral for the loan.
Loan amount: The total amount of money being borrowed.
Interest rate: The rate at which interest will accrue on the loan amount.
Loan term: The duration over which the loan will be repaid, including the start date and the maturity date.
Repayment terms: Details about the payment schedule, including the amount of each payment, the frequency of payments (e.g., monthly), and the total number of payments.
Legal obligations: The borrower’s obligations under the mortgage, such as maintaining homeowners’ insurance, paying property taxes, and keeping the property in good condition.
Default and foreclosure: Conditions under which the lender can declare the loan in default and the process for foreclosure if the borrower fails to meet the repayment terms.
Rights of the lender: Any rights reserved by the lender, such as the right to inspect the property or to require the borrower to take specific actions to protect the lender’s interest in the property.
Riders or addenda: Additional documents or clauses that modify or add to the terms of the mortgage based on specific circumstances or requirements (e.g., an adjustable-rate rider for an adjustable-rate mortgage.

A. Financing

Is a promissory note required to finance the purchase of a property?

A promissory note can be used to finance your purchase and it’s technically as that’s needed for financing.

Is a mortgage deed requirement to finance the purchase of a property?

Even though it is more common to see promissory notes used independently in owner-financing scenarios, it is still recommended that you use a promissory note in conjunction with a mortgage deed. The combination of the two ensures that you have proper recourse if the borrower stops making payments on their loan.

B. Recording

Are mortgage notes recorded?

Mortgage deeds are typically recorded as a matter of public record. In the US, they’re recorded at the registry of deeds. When you take out a mortgage, the lender has something called a “mortgage lien” or a legal claim to the mortgaged property. He can enforce this claim against anyone who acquires a future interest in the property.

Registering the mortgage deed ensures that the public is aware of the lender’s legal claim to the property. It also protects innocent third parties from being misled by fraudulent borrowers into fully paying for mortgaged properties under the false assumption that they are free of any mortgage.

Are promissory notes recorded?

Promissory notes, on the other hand, are generally not recorded and are merely kept in the payee’s records until such time as they are paid in full. After they are paid in full, they are usually given to the payor as proof that they own the property outright.

C. Sale

Can a promissory note be sold?

When people talk about selling mortgage notes in the secondary markets, they are talking about promissory notes. If, for example, someone used a promissory note to secure an owner financing deal and then decided that they didn’t want to wait many years for repayment, they would have the option of selling their note to one of the many companies that buy mortgage notes. In exchange, they typically receive a lump-sum payment.

Can a mortgage deed be sold?

Mortgage deeds, on the other hand, cannot be sold. Though, notably, some mortgage deeds do contain what’s known as a “due-on-sale clause,” which calls the entire loan due if the property is being sold. These clauses have a tendency to make it much harder to sell your home without paying off your loan in full first.

All a mortgage provides is security for a loan. If you want to transfer the legal claim to that security to someone else, you can only sell the property itself to that person. The mortgage deed will then be updated to reflect the new mortgagee (lender).

D. Which document is your promise to pay back the home loan to the lender?

One of the most obvious things you’ll notice when looking at a mortgage vs promissory note in real life is that the mortgage doesn’t contain any statement reflecting the borrower’s promise to pay back the home loan. Simply put, a mortgage is a contract that gives the lender the right to seize your home if you don’t repay the loan. It doesn’t state that you promise to pay back the home loan to the lender. A promissory note, on the other hand, is a clear statement of that promise.

E. Who has the obligation to repay?

In the cases of both a promissory note and a mortgage, the obligation to repay rests on the party that agrees to repay. This party is usually the borrower but in some cases, it may be a third party.

Consider this hypothetical scenario, the questions raised, and the answers:

Scenario:

In 2024, Jacob Whitman purchases a home in Austin, Texas, for $400,000. To finance the purchase, he takes out a mortgage loan from Lone Star Bank, signing both a promissory note and a mortgage.

The promissory note states that Jacob personally promises to repay the loan amount of $400,000 plus interest over 30 years with monthly payments of $2,500.

The mortgage document secures the loan by granting Lone Star Bank a lien on the property, allowing foreclosure if Jacob defaults.

One year later, Jacob sells the home to Michael Rodriguez through a private agreement. Instead of obtaining a new mortgage, Michael agrees to take over the monthly payments. However, Jacob does not formally transfer the mortgage or promissory note to Michael, and Lone Star Bank is not notified.

After another two years, Michael stops making payments. Lone Star Bank forecloses on the home, selling it for $350,000. The bank then seeks to recover the remaining $50,000.

Discussion:

Who is legally obligated to repay the loan—the original borrower (Jacob) or the third party (Michael)?

Jacob is still legally obligated to repay the loan because he signed the promissory note, making him personally responsible for the debt. The mortgage only secures the loan with the house. It does not transfer repayment responsibility to Michael.
Since Michael did not formally assume the mortgage with the lender’s approval, Lone Star Bank has no legal contract with him.

Does the mortgage or promissory note dictate who is responsible for repayment?

The promissory note determines who is obligated to repay. In this case, Jacob remains liable because his name is still on the note. The mortgage only gives the bank a security interest in the home, allowing them to foreclose but not changing the borrower’s repayment obligation.

Can Lone Star Bank sue Jacob for the remaining $50,000? Can they sue Michael?

Lone Star Bank can sue Jacob for the deficiency because he signed the promissory note and is still the official borrower.
The bank cannot sue Michael because he never signed the note and has no formal agreement with them.
If Texas allows deficiency judgments, the bank can pursue Jacob for the remaining $50,000. If Texas law prohibits deficiency judgments, Jacob may not owe anything beyond the foreclosure sale.

How could Jacob have avoided liability when selling the home to Michael?

Jacob could have protected himself by:

Releasing his liability through loan assumption: He should have worked with Lone Star Bank to formally transfer the mortgage to Michael, making Michael legally responsible.
Requiring Michael to refinance: If Michael obtained a new mortgage in his own name, Jacob’s loan would have been paid off, removing his liability.
Using a legally binding agreement: If Jacob had included legal protections in his private sale contract, he might have had grounds to recover losses from Michael.

F. What happens if you repay the loan in full?

If you repay the loan in full, both the promissory note and the mortgage are effectively settled, but they are handled in different ways.

Promissory note

Since this is the borrower’s personal promise to repay the loan, full repayment satisfies the obligation. The lender should mark the note as “Paid in Full” or “Canceled” and return it to the borrower. This confirms that the borrower has no further liability.

Mortgage

The mortgage (or deed of trust in some states) serves as the lender’s security interest in the property. Once the loan is fully repaid, the lender must release the mortgage lien. This is done through a Satisfaction of Mortgage (or Deed of Reconveyance in deed of trust states), which is filed with the county recorder’s office to remove the lender’s claim on the property.

While it’s uncommon, a mortgage could exist without an accompanying promissory note if the arrangement solely involves the right to the property as collateral without a formal promise of repayment. However, in practice, this scenario is highly unusual and not practical for typical lending transactions. Lenders usually require both documents to provide a clear legal obligation for repayment and a means to enforce that obligation through the property if the borrower defaults.

Yes, a promissory note can be used without a mortgage. Promissory notes are versatile financial instruments, and they are not exclusively tied to real estate transactions. They can be used in various lending situations ranging from personal loans between individuals to business financing, where no collateral is necessarily involved.

Unlike a mortgage, which secures a loan through a lien on real property, a promissory note does not inherently require collateral to be valid and enforceable. This flexibility makes promissory notes a common choice for a wide array of lending agreements beyond the realm of real estate, where the borrower’s promise to repay the lender is based on trust, creditworthiness, or other forms of security rather than a specific claim on property.

Mortgage Note vs Promissory Note: The Bottom Line

Anyone about to buy real estate or sell property usually has to consider whether a promissory note or a mortgage is needed. Even though it’s best to use both a promissory note and mortgage to finance a purchase, the mortgage note definition and the promissory note definition are very different. Use this post as your guide to the differences between the two. With this knowledge, you’ll be able to tell the two apart and to understand what can be done with each one.

What’s the Difference Between a Mortgage vs Promissory Note in Real Estate?

Key Takeaways