What is a Promissory Note
A promissory note is a document that is signed with a promise to pay back a stated sum to a specific person or bearer, at a specified date or on demand. This type of document can be written up for nearly any type of item out there that can be purchased and requires a loan.
A great number of promissory notes are created every year, and thousands are sold annually. Who buys these notes? How do they purchase them? What should I look for when selling my own note?
As a promissory note is a signed document that states a borrower has promised to pay what is owed (that they loaned) on the item in question, this can include a variety of types of real estate. For example, Residential homes, commercial properties, multi-family homes, land, and mobile homes to name a few.
Unsurprisingly, banks hold the majority of mortgage notes but many companies and individuals buy and hold notes themselves, too. An individual does not have to be a business owner—many are people who are selling their home. You will find out how they complete this process below.
How Does an Individual Hold a Promissory Note?
The most common situation a person finds themselves in when they end up holding a mortgage note, is when they sell their residence via Owner Financing. This type of selling of one’s home is when an interested party buys the home of the note holder (the seller) and pays them a monthly mortgage, rather than through a banking institution or lender. This means that a buyer can by-pass traditional banks during the house buying process and find an owner-financer selling their home, and pay back the loan directly to the original owner of the house. That original owner is now a mortgage note holder.
This note holder now holds the promissory note that reflects the agreement that the home-buyer will pay monthly payments (or other agreed upon installments) to the note holder. This process is essentially when someone sells their home and acts as the lender of the home they are selling, rather than asking the buyer to go to a traditional lender or bank. The note holder acts as the lender themselves, and is paid by the new home owner.
There are also times when an individual finds themselves holding a promissory note ( mortgage note), such as when they become the beneficiary of an inheritance. Along with, or besides cash, belongings, or other material goods, a person may be given a note as an asset instead of receiving an inheritance.
What is the Difference between a Promissory Note and a Mortgage Note?
There is a fundamental difference between a promissory note and a mortgage note. A mortgage note (also called a deed of trust), is a document that provides the security for the loan. The promissory note is the actual binding document with the promise to pay back the loan. Each document should contain items to be considered a promissory note or a mortgage.
The promissory note will include the name of the borrower (payor), the address of the property in question (if applicable—note applicable if it is land, for example), the interest rate agreed upon—either fixed or adjustable, the amount of the loan, the term (or number of years of the loan), and a late charge amount for late payment.
It will also include both the lender’s (payee) and borrowers’s (payor) rights and responsibilities as the note holder. This promissory note is note recorded in county land records. It is more like the pink slip when selling a vehicle. The lender is the individual who holds the promissory note during the time the loan is outstanding. When the loan is finally paid off in full, the note is then given to the borrower (buyer of home) and the deed is transferred to them. Promissory notes can be used for a variety of loans such as commercial loans, bank loans, student loans, and real estate loans. It does not necessarily have to be tied to a physical piece of property.
A mortgage note will include the name of the borrower, the address of the property, and the legal description of the property. It will also contain a clause that will allow the lender (note holder) to demand the entire balance of the loan should the borrower (payor) default on the loan. This is what makes a mortgage note a solid investment for a note holder, and a liquid asset. This demand in case of default is called an Acceleration Clause and if the borrower (payor) continues to default on payment of the loan, the lender/note holder can begin foreclosure proceedings, and the actual property can be sold to satisfy the debt.
Unlike promissory notes, the mortgage note is recorded in the county records after the borrower has signed it. When the loan is fully paid off, the lender will record that the loan has been paid off and the remaining debt satisfied, with the county land records.
When purchasing a home, the borrower will be signing two different documents: the promissory note and the deed of trust.
Another difference is a promissory note is a negotiable instrument that can be transferred or sold (or endorsed—e.g., signed over), to a new owner at any time. When the new owner of the note attempts to collect on the note, a letter will be sent to the borrower asking for repayment. This should include a copy of the promissory note so the borrower is aware of the change of ownership.
If you are unsure about whether you are dealing with a promissory note or mortgage note, it is always suggested that you consult with a professional.
Who Can Buy My Promissory Note?
Private individuals purchase promissory notes on their own, but it is definitely wise to use an established and experienced company who has the knowledge and funds to buy notes. In some cases, a banking institution may wish to buy your note, as they are the majority of note holders in the nation.
However, for most note holders wishing to sell their note, a note buyer whose business it is to buy and invest in promissory notes will likely be the ones to purchase the note from you
What to Gather In Order to Prepare to Sell Your Note
During the preparation to sell your note, it is very important that you gather all records. Gather the records that confirm payments received, property insurance policies, property tax payments, and the original information on details of the note (e.g., property address, amount of the loan, interest rate, and the terms). There may be much more paperwork needed when it comes time to sell the note but this is a start.
The potential buyer of the note will likely want the current credit report of the borrower currently living in the home. This is their way of protecting this investment and minimize risk should they purchase the note.
What to Expect When Selling Your Note
It is important to think that you are going to get the full value of the note. Note buyers are in the business of buying and investing notes and generally offer a discount on the note’s value. This is common because a note holder can cash out and receive a lump sum of cash while the note buyer can minimize their risk by purchasing the note at a discounted price.
There are risks of the note defaulting, which note buyers take into account. This, and the time and effort that goes into buying the note equals a discount on the value of the note. Depending on a number of different factors, a note seller can expect an offer anywhere from 60% to 90% of the value of the note. This is a broad range and could be more or less depending on how each note is valued, if the payments have been paid by the borrower on time, the credit of the borrower, current real estate market, or other factors.
The seller gets the cash up front, but note buyers expect a seller to realize that they, as the new note holder, would then assume all of the future risk.
Note Brokers vs Note Buyers
Many people mistakenly refer to a “note buyer” and a “note broker” as the same thing. However, there is a significant difference between the two professional roles.
Note brokers are similar to real estate brokers. A note broker’s job is to bring together note sellers and note buyers for transactions. The broker acts like the middle man, dealing with the transaction between the investor/note buyer and the note seller. The funding of money does not come from the broker—it comes from the note buyer/investor when the note is bought and the seller is paid.
There are benefits from using a note broker. There are a lot more note brokers working than note buyers purchasing, so you should be able to find a local note broker rather easily. They have a great knowledge of the process as well, and can make your transaction much easier, including finding a buyer for you.
Unlike note brokers, note buyers are typically large companies that offer their services across the nation and a third party is not needed because the buyers purchase the notes straight from the seller. The buyer will generally have their own funds and can buy directly from the seller. One of the positive aspects of this, is the transactions are much quicker. Since the buyer does not have to go looking for an investor to fund the purchase, the process is easier and simpler. Buyer will have their set of guidelines which will determine whether they personally, should and can, make a purchase, and with a note buyer, they are able to notify a note seller promptly whether they can or not, depending on their funding.
Note buyers have the experience in this industry that is hard to beat. To become a note buyer, you must FIRST become a note broker—this experience ensures that note buyers are experienced and competent to purchase a note without a third party involved.
So, you can see, a note buyer and a note broker have their different jobs in the business and both have their own benefits. You must make the decision who you would prefer to use during your own note transaction using your own good judgement.
When you are selling your note, it is in your best interest to deal with and sell to an established company that has experience of buying notes. Many note buying companies work investing and buying notes that range in price from a few thousands to millions of dollars (the latter if they are backed by large financial investors).