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Promissory Notes Explained

A promissory note is a legally binding agreement between a lender and a person borrowing money. Promissory notes are similar to other financial agreements or contracts as they come with specific terms and conditions. They do, however, have certain specifications that you won’t find in any other types of financial agreements.

Basic Promissory Notes

A promissory note is used when money is being borrowed and lent. They are designed by companies and individuals as a guarantee that the money will be repaid by a certain date. The are also agreements that are unconditional between the borrower and the lender.

A promissory note can also be used in connection with another type of service. There is one difference when a promissory note is used in this manner. Even if the original agreement, service, or contract did not occur, the amount of money agreed upon would still be due. A promissory agreement will stand on its own and the repayment promise is unconditional. This means that regardless of what happens between the lender and the borrower, repayment is still required. Promissory notes will always have a set of conditions and terms written in the agreement.

The Guarantees of a Promissory Note

Since a promissory note is an agreement between to parties, the actual terms and conditions that are included in the promissory note can be determined during a discussion or through written correspondence between both parties. Most promissory notes are written contracts, however, a verbal agreement regarding the conditions and terms are still binding.

There are certain things that are included in the promissory note. Unlike a typical legal document, promissory notes are not full of legal jargon that you cannot understand. As long as the terms and conditions in the promissory note are easy to understand and clearly defined, there is no need to hire a lawyer. If large sums of money are involved, however, it is a good idea to get some legal advice.

Details in a Promissory Note

No promissory note will be the same since the terms and conditions can vary. There are, however, some details that are used in all promissory notes. These include:

  • The name of the borrower and the name of the lender
  • The physical address of the borrower
  • The principal amount of money being borrowed
  • The length of the loan period.
  • Whether or not interest will be charged. If it is, the interest rate would be included in the promissory note.
  • Information regarding defaults and the penalties for doing so.
  • Whether it is going to be a secured loan or an unsecured loan.
  • Signatures from both parties and the signatures of people witnessing the signing.

This is not a definitive list. There are certain terms and conditions that can be added by the borrower and the lender. This can be anything. A good example is specific terms regarding the repayment or compounded interest.

Unfair Terms

If there are any clauses in the promissory note that are unclear or if one party signed the promissory note under duress, and the dispute reaches the courts, the document might not be enforced. This is also true if there is any type of unbalance in the note, and it is biased toward one party. If the terms of the note seem unfair, such as very high-interest rates, the note might not be enforced.

Signatures

After the terms and conditions of the note have been ironed out and accepted, the note would be signed by both parties. The lender should keep a copy of the note until all money has been repaid and all of the terms and conditions have been met.

Promissory notes are also known as loan notes and IOU’s, however, the basic principals apply. With a loan note and an IOU, money has been borrowed and the repayment can be legally enforced. It is in the lender’s best interest to read all of the terms and conditions of the financial contract thoroughly before signing anything that can be binding.

What Is the Difference Between a Promissory Note and a Mortgage?

When a person takes out a loan to buy a home, they are required to sign two documents. One is the mortgage (deed or trust), and the other is the promissory note. If you want to learn the difference between the two documents and how they will relate to your mortgage transaction, read on.

Home buyers often think of their mortgage agreement or deed as the necessary contract to borrow the money that they need to buy their home. It isn’t the mortgage that contains the promise to repay the money, it is the promissory note.

The promissory note is an IOU that contains the borrowers promise to repay the loan. It also contains the terms for repayment. A promissory note will also contain the following:

  • The name or names of the borrower
  • The address of the property that the individual borrowed the money to purchase
  • The interest rate and whether it is adjustable or fixed
  • The amount of the late charge if a payment isn’t made on time
  • The amount of money being borrowed
  • The term of the loan (number of years that it will take to repay the loan)

A mortgage or deed is recorded in the county land records, and a promissory note is not. While the loan is outstanding, the lender will hold the promissory note. When the loan has been paid in full, the note will be marked as paid and then returned to borrower.

Mortgages and Deeds of Trust

The purpose of the mortgage is to provide security for the loan that is written up in the promissory note.

Along with the standard agreements made between the lender and the borrower, the mortgage will also contain an acceleration clause. This clause would permit the lender to require that the entire balance of the loan is paid off if the borrower doesn’t make payments and defaults on the loan. If the borrower doesn’t pay what they owe on the promissory note, the actual property can be sold to satisfy the debt. Before the lender can accelerate the loan, they must notify the borrower. If the borrower does not resolve the problem in a way that will satisfy the lender, they can begin foreclosure proceedings. If you are unsure of what foreclosure is, it is the legal process where the property is seized by the lender and sold to another party to repay the remaining debt in the promissory note.

The mortgage or deed will include:

  • The names of the borrowers
  • The address of the property that the individual borrowed money to purchase
  • A legal description of the property in question

Shortly after the borrower signs the mortgage, it would be recorded in the county land records. When the full amount of the loan is paid off, the lender would record a release of the deed in the county land records.

Loan Transfers

It is not uncommon for banks to sell and buy mortgages from one another.

Assignments: An assignment is the legal documents which contains the information regarding the transfer of the mortgage from one bank to another. All assignments need to be recorded in the county land records.

Endorsements: When the loan changes hands from one bank to another, the promissory note needs to be endorsed or signed over to the new owner of the loan. There are cases where the note needs to be endorsed in blank. This makes it a bearer instrument under the Uniform Commercial Code, article 3. This means that any party that owns the note has the legal right to enforce it.

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