Promissory Notes And Deeds Of Reconveyance
Financing is one of the largest hurdles real estate investors face when buying properties.
When it comes to securing a mortgage, lenders are clear about when and what will be due . Your monthly payments may change if your loan is adjustable, but your obligation to pay them will not.
That’s where promissory notes and deeds of reconveyance come in. These two documents are the bookends of your mortgage loan, setting you up for a journey to eventually gain the full property title.
In this article, we’ll explore how promissory notes bind borrowers and lenders, outlining repayment terms and legal obligations, in addition to the role of deeds of reconveyance in signaling mortgage completion.
What is a Promissory Note?
A promissory note is a debt instrument with a written promise between two parties (a promisor/issuer and a promisee/payee) to pay a specific sum of money at a certain time. The note is canceled when the promisee/payee has paid off the entirety of the loan.
These notes serve as a middle ground between the informality of an IOU and the formality of a loan contract, and they are required for every lending transaction.
Promissory notes are commonly issued by banks when a borrower takes out a loan, but they can also be issued by other financial institutions/lenders or even individuals who agree to carry the note and provide financing. For instance, a person borrowing money from their relative might sign a promissory note to promise repayment to them.
A basic promissory note typically includes borrower and lender details, the loan amount, payment schedule, interest rate, prepayment options, default terms, and governing law. Understanding promissory notes is crucial in comprehending financial obligations and transactions, especially in comparison to other documents like deeds of reconveyance.
What’s the difference between a mortgage promissory note and a mortgage note?
These two terms have similar meanings but aren’t exactly synonymous. Each is a legal document. Promissory notes are written promises to repay a borrowed amount, which means all mortgage notes are promissory notes. However, not all promissory notes are mortgage notes. As mentioned above, a promissory note could be a promise between an ordinary individual willing to lend money and a borrower, in which case the note is not a formal mortgage note like a bank would provide but is still a legal agreement promising repayment.
For small amounts borrowed between friends or family members, a promissory note probably isn’t necessary. However, large amounts which the lender expects to be fully repaid require a promissory note. This makes the loan legally enforceable.
Types of Promissory Notes
There are several different types and classifications of promissory notes.
Secured vs. Unsecured Promissory Notes
A secured promissory note is a promissory note secured by collateral (e.g., a car or another property). If the promisee/payee defaults on the loan, the promisor can seize and sell the asset designated as collateral to make up for their loss. On the other hand, unsecured promissory notes are not secured by collateral. If a promisee defaults on an unsecured promissory note, their lender will have to use standard debt-collection processes to offset the loss.
Varying Purposes
Promissory notes also vary in type depending on the purpose of the loan:
- Student loan promissory notes. These notes designate the repayment of a student loan. Federal student loans often require a master promissory note to set up repayment of principal, interest, and fees to the U.S. Department of Education.
- Car loans. Promissory notes are also common for auto loans.
- Mortgage promissory notes are for home loans. Like the mortgage document, they include the terms and conditions of the mortgage established by the mortgage lender, repayment plan/dates, any adjustments possible for the interest rate, etc.
- Personal loans. This would be small loans from a bank, lender, or other individual/entity used for personal purposes.
- Corporate credit promissory notes are used for short-term business financing. If companies need funds in the short term to be able to cover company costs or bring in income before a product is on the market, a promissory note may be required. A corporate credit promissory note could also be issued by a bank in exchange for cash. They are registered with the state government and the Securities and Exchange Commission (SEC).
- Master promissory notes (MPNs) are ongoing promissory notes that can cover multiple loans. These are common with student loans issued by the federal government and are issued at the beginning of a student’s first term to cover all the loans the student will need throughout their education (keep in mind, however, that this differs for mortgage loans – a new promissory note is required every time you refinance a mortgage).
Types of Repayment Structures
Promissory notes also vary with regard to the type of repayment structure. Repayment structures outline the terms agreed upon by both parties, dictating how and when the loan will be repaid. Possible repayment structures include:
- Installments (e.g., regular monthly payments)
- Simple notes (e.g., a lump sum payment on a certain date)
- Open-ended notes (like a line of credit, where a borrower only receives part of the funds up front, then they can later draw more funds without getting a new note)
- Demand notes (the payment may be due anytime at the lender’s request)
- Balloon promissory note (similar to a balloon mortgage, this option is where the borrower makes small payments at first and then one, large balloon payment towards the maturity date).
Failure to repay as per the agreed-upon structure can lead to a defualt action being taken against you. When engaging in promissory notes, consider the legal implications carefully to ensure compliance and protect your interests.
Contents of a Promissory Note
Promissory notes contain details about the loan and repayment schedule, including:
- Name, addresses, and contact information of both parties
- Loan amount
- Interest rate
- Maturity date (the date that the loan’s principal, and all interest accrued, is due)
- Repayment schedule (e.g., equal payments distributed over a certain number of years? A lump sum?)
- The date the first payment is required
- The amount of the first payment and all subsequent payments
- Additional fees or charges
- Other terms and conditions
- Any collateral (for secured promissory notes)
- What happens if the borrower defaults
- The borrower’s/payee’s signature, to ensure the note is legally binding
Many promissory notes also include information about the governing law for the promissory note.
Promissory Notes in Real Estate
In real estate, buyers are required to sign mortgage promissory notes in addition to the mortgage agreement itself. This represents the formal, legal obligation to repay the home loan according to the terms of the loan agreement.
When a buyer obtains financing for a new home, the property title is often used as collateral. This means the lender can foreclose on the property if the borrower defaults on their mortgage payments.
When your mortgage is fully paid off, the lender will cancel the promissory note and you will obtain full ownership of the property.
What is a Deed of Reconveyance?
Now that we’ve looked at promissory notes, what is a deed of reconveyance?
A deed of reconveyance could be considered the opposite of a mortgage promissory note. These are legal documents that signify when a mortgage loan is fully repaid, transferring the property title from the lender to the borrower. A deed of reconveyance is also called a satisfaction of mortgage or full reconveyance form in some states.
Recording these deeds with the proper government entities is vital for proving ownership during property sales and preventing any future disputes. Deeds of reconveyance need to be recorded officially in the local county clerk’s office or recorder’s office. This ensures that if the borrower sells the property in the future, a property title search will come back clear (i.e., a records search will confirm that the buyer fully owns the asset and there are no active liens indicating an unpaid mortgage).
Borrowers can sell the home without a deed of reconveyance if part of the mortgage is still unpaid; however, the deed will be included in the closing process of the property and handled by a title insurance company. The same applies in a refinancing situation or home equity loan.
Once a borrower has made their final mortgage payment, a deed of reconveyance is created and notarized by the lender. After the borrower receives it, their property can no longer be foreclosed on.
A note on terminology: Conveyance refers to transferring a property title from one individual or entity to another; a reconveyance refers specifically to transfer from a bank/lender to the borrower after the latter has paid off the mortgage.
Contents of a Deed of Reconveyance
Deeds of reconveyance are typically issued within 30 to 60 days. Their contents include:
- Names, addresses, and contact information of both parties
- A description of the property
- Documentation that the mortgage has been repaid and that the previously held property held as collateral is now fully owned by the borrower
- Signatures of all parties
- Notarization
Implications of Promissory Notes and Deeds of Reconveyance for Real Estate Investors
As a real estate investor who has received financing for a property and signed a promissory note, promissory notes and deeds of reconveyance are significant milestones in the loan payment process. You can face foreclosure if you don’t make payments before receiving a deed of reconveyance, or even after you receive one if you don’t pay your property taxes.
A deed of reconveyance is required before you can sell an investment property – the new buyer’s agent will perform a property title search to ensure that the deed has been recorded and the title is free and clear. If the mortgage hasn’t been fully paid at the time of the sale, the buyer’s payment will be contributed to the loan which triggers the deed to issue – all of which is handled by the title company.
These documents signal financial responsibilities between parties in a lending transaction and ensure important milestones in the creation and completion of a loan are properly documented and recorded with local governments.
Conclusion
Now that you understand the importance of promissory notes and deeds of reconveyance in real estate transactions, you can confidently navigate the complexities of property dealings.
By knowing how these documents bind borrowers and lenders, outline repayment terms, and signal the completion of mortgage payments, you’re equipped to protect your homeownership rights and make informed decisions.
