What is a Mortgage Note?
A mortgage note (also called a promissory note) is the legal document in which a borrower promises to repay a home loan according to specified terms. The note contains the loan amount, interest rate, payment schedule, maturity date, late payment provisions, and default remedies. It is the borrower's personal promise to pay -- a debt obligation -- while the mortgage or deed of trust is the separate document that pledges the property as collateral for that debt.
Note vs. mortgage
These two documents work together but serve different purposes. The note creates the debt obligation. The mortgage (or deed of trust) creates the lien on the property that secures the debt. If a borrower defaults on the note, the lender uses the mortgage to foreclose on the property. Without the note, there is no debt to collect. Without the mortgage, there is no property to foreclose on.
Key terms in a mortgage note
Principal amount: The total borrowed. Interest rate: Fixed or adjustable, expressed as annual percentage. Payment amount and schedule: Monthly payment, due date, where to send payments. Maturity date: When the loan must be fully repaid. Late charges: Penalty for payments received after the grace period (typically 15 days). Prepayment provisions: Whether the borrower can pay off the loan early without penalty. Default provisions: What constitutes default and what remedies are available to the lender.
Mortgage notes as investments
Mortgage notes are tradeable financial instruments. Banks, mortgage companies, and private lenders sell notes to investors who want the income stream from the borrower's payments. Performing notes (borrower is current) and non-performing notes (borrower has defaulted) are both actively traded. Note investing allows investors to earn returns backed by real estate without the responsibilities of property ownership.
Seller-financed notes
When a property seller provides financing to the buyer, the seller creates and holds a mortgage note. The seller receives monthly payments from the buyer and holds a lien on the property. These seller-financed notes can later be sold to note investors if the seller wants a lump sum instead of continued monthly payments. The note typically sells at a discount to its face value, with the discount reflecting the note's terms, the borrower's payment history, and the property's value.