Though a promissory note and a mortgage work together to create a legally binding loan agreement, each has its own distinct purpose in finalizing a real estate transaction. When you sign a promissory note, you’re agreeing to pay back the loan amount under specific loan terms. When you sign a mortgage, you’re acknowledging that if you default on that loan, the lender can get its money back by foreclosing on the property.
These separate contracts have important roles in your purchase, so before you sign on the dotted line, read on for an explanation of how each one works.
Promissory Note vs Mortgage
If you’re borrowing money to buy real estate, you’ll likely be asked to sign both a promissory note and a mortgage at your closing. And in the blur of paperwork, it may seem as though they’re pretty much the same thing.
They aren’t. Here’s a look at the role each document has in finalizing a home loan agreement.
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What Is a Promissory Note?
You can think of a promissory note as a formal and really specific IOU. It’s the borrower’s promise to repay the loan by a predetermined date, and it typically details the terms of the loan, including the loan amount, the interest rate, the length of the loan, and monthly payments (all the factors you would see in an online mortgage calculator).
If you sign the promissory note, sometimes referred to as a mortgage note, you are obligated to pay back the loan under these terms.
What Is a Mortgage?
A mortgage is the contract you sign with the lender that states that the property you’re purchasing serves as the security, or collateral, for the loan. It contains a legal description of the property and usually notes that you’re responsible for things like maintenance and for carrying homeowners insurance.
The mortgage doesn’t obligate you or anyone who signs it to repay the loan, but it does allow the lender to take the property as collateral if you don’t make your payments or if you otherwise fail to follow through on the terms of the loan. If you default, the lender can proceed with a mortgage foreclosure and then sell the home to recover its money.
Recommended: What Are the Different Types of Home Mortgage?
Key Similarities and Differences Between a Mortgage and Promissory Note
Because the paperwork a borrower completes and signs for a real estate loan is often referred to, in general, as the “mortgage,” it can be easy to lose sight of the different purposes of the mortgage and promissory note. So here’s a quick breakdown of some of their similarities and differences.
Similarities Between Promissory Notes and Mortgages
• Both documents establish a legally binding contract that ensures the lender is protected if the borrower defaults on the loan.
• Some of the terms of the promissory note may also be listed in the mortgage, including the length of the loan and the amount due. (The interest rate and monthly payment usually aren’t included on the mortgage, however, and won’t be a part of the public record.)
• Both are important documents that you should read (and understand) before signing.
Differences Between Promissory Notes and Mortgages
• Each document has a distinct purpose and legal implication. A signed promissory note serves as the borrower’s promise to repay the home loan. A signed mortgage secures the note to the property and says you agree the lender can foreclose on your property if you default on the terms of the loan.
• Each document contains different pieces of information. While the promissory note lists more details about the loan terms, including the interest rate and repayment schedule, the mortgage has more details about the borrower’s obligations and the lender’s rights.
• There’s also a difference in where each document is kept after the closing. The lender holds onto the promissory note until the loan is paid off. (After that it can serve as the borrower’s “receipt,” proving the loan is paid — so it’s important to make sure you keep it in a safe place when you receive it.) The mortgage becomes part of the county land records to provide a traceable chain of ownership.
• Each document confers a different obligation on those who sign it. Anyone who signs the promissory note can be held personally liable for the borrowed money and could face legal consequences if they fail to make their payments. If, for example, the lender forecloses on the home and sells it, but the sale doesn’t cover the amount you owe, you may be responsible for paying the difference, depending on state laws. However, if you sign only the mortgage document and not the promissory note, the lender can’t hold you legally responsible for paying back the loan; you’re only giving the lender permission to foreclose on the property if the loan isn’t repaid.
|
How Promissory Notes and Mortgages Compare |
||
|---|---|---|
| Promissory Note | Mortgage | |
| Protects the lender if the borrower defaults | x | x |
| Outlines terms of the loan agreement | x | x (with limits) |
| Establishes borrower’s legal promise to repay loan | x | |
| Establishes lender can foreclose upon default | x | |
| Is held by the lender until loan is paid | x | |
| Is filed in county records | x | |
| Should be read and understood before signing | x | x |
Required Documents to Get a Mortgage
You should be prepared to provide and sign several documents during the homebuying process — first on the front end, when you’re applying for a loan, and again later, when it’s time to close on the property.
The person who’s in charge of your closing can give you a complete list of what you’ll need to bring with you and the paperwork you’ll be asked to sign, but here are a few of the documents you can expect to see:
Closing Disclosure
The Closing Disclosure lays out the final terms of the loan, including all closing costs, and provides information about who is paying and who is receiving money at closing. Lenders are required to send buyers a copy of their Closing Disclosure at least three business days before closing so there’s time to review it and clear up any potential discrepancies. You should bring it with you to your closing to be sure your costs remain the same as you expected or that any necessary changes were made.
Promissory Note
The promissory note is the document that states that you legally agree to repay your home loan. It provides important details about the loan, including the amount owed, interest rate, dates when the payments will be due, length of the loan, and where payments should be sent.
Mortgage/Deed of Trust/Security Instrument
This document gives your lender the right to foreclose on your property if you fail to live up to the repayment terms you agreed to. It also will outline your responsibilities and rights as a borrower.
(Your state may use a deed of trust vs. a mortgage as part of the home loan process. A deed of trust states that a neutral third party — usually the title company — may hold legal title to the home until the borrower pays off the loan.)
Initial Escrow Disclosure
This form explains the specific charges you may have to pay into an escrow account each month as part of your mortgage agreement, such as money to cover property taxes and insurance.
Deed
This document transfers ownership of the property from the seller to the buyer.
Right to Cancel Form
You’ll only see this form if you’re refinancing your home loan (it doesn’t apply if you’re purchasing the property). It states your right to cancel the loan within three business days and explains how that process works.
Recommended: What Is Mortgage Underwriting?
The Takeaway
Though people tend to think of the term “mortgage” as describing everything that has to do with their home loan, there are actually two separate documents that form the legal agreement between a buyer and a lender and outline their responsibilities.
It’s important to understand the differences between these two distinct pieces of paperwork — the promissory note and the mortgage — before you see them at your closing. You’ll also want to carefully review them — and all the forms you see — before you sign for your loan.
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FAQ
Do you need a promissory note and a mortgage to buy a house?
Usually, yes. But you might have a promissory note without a mortgage if you’re using an unsecured loan from a family member, a friend, or the seller.
Is a promissory note the same as a loan?
A promissory note is part of a formal loan agreement. It contains a promise from the borrower to repay a specific amount of money to the lender under designated terms.
What is the purpose of a promissory note in real estate?
The promissory note helps formalize the terms of a real estate loan, including the length of the loan, the interest rate, how and when payments should be made, and what happens if the borrower defaults.
Does a promissory note create a lien?
No. A promissory note obligates the borrower to repay the loan, but it does not “collateralize,” or secure, the loan to the property.
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