Part 1 – The Basic Facts About Notes
If you look up “Note” in the dictionary you will find many meanings attached to this four letter word. In the real estate industry, however, the Note invariably is “a written promise to pay a debt”. In this article, references to the “Note” are based on a Note generated under California laws.
In an escrow transaction, the Escrow Holder may be requested by parties to prepare the Note if the Lender is a private party who does not have the forms or the expertise to do so. Be sure you consult with your legal counsel once these forms are prepared.
There are two basic types of Notes that can be used to outline a debt: an unsecured Note, or a securedNote. One prime example of an unsecured Note is our everyday check drawn from our checking account.
There are normally two parties in an unsecured Note and three in a secured Note:
- The “Payor” is the person who is paying the money (or Borrower)
- The “Payee” is the person who is getting the payment (or Lender)
- The “Trustee” is the neutral 3rd party under a secured Note who will issue the release of the loan once it is paid off
Whichever type of Note is being used there are certain requirements that must be incorporated into this instrument. It must be:
- In writing
- Have an amount
- Have a date on the instrument
- Have a date for payment
- There must a person it is to be paid to (Payee)
- There must be a person who is paying (Payor/Maker)
- Both the Payor and Payee must be legal entities **
- The instrument must be signed by the Payor
** Legal entity – an entity whose existence is recognized under State and Federal laws. Example – a natural person or an incorporated organization. Not a legal entity – dbas, Fido, your French poodle.
Some of the other items that can be put on the Note, depending on the conditions, are as follows:
- Interest rate if charged
- When interest starts
- How are payments to be made
- Starting date
- Ending date or term of the Note (how long it is for)
An unsecured Note, like a check, is not backed by any type of security besides the Payor’s own personal integrity and ability to pay. If the Payor should not pay, the Payee’s only avenue of collection would be by going to court. However, an unsecured Note can attach to anything the Payor owns.
A secured Note is one that is given with the specific intent of backing it by real estate owned by the Payor. If the Note does not get paid, the Payee can foreclose on the real estate. With this type of a Note, there are other conditions required under California laws:
- A Deed of Trust (or Trust Deed) which puts the loan on the Payor’s property must accompany the Note.(Read our Deeds of Trust page, for all the basic facts)
- The Note and Deed of Trust must have a “Trustee” – a disinterested third party who is called upon to issue the Reconveyance when the loan is paid in full
- Certain agreed upon clauses must show in the Note as well as the Deed of Trust
- If Payor does not pay, the Payee can start foreclosure proceedings, whether judicial or non-judicial, to recoup on the debt
There are different types of secured Notes. The most commonly used are:
- Installment Note – most common, where monthly payments are a set amount for principal and interest throughout the term of the Note
- Interest only Note – monthly payments are interest only and principal is paid only at maturity
- Straight Note – payment of interest and principal are due at one time in one lump sum
Besides the interest rate and the term of the loan, there are other conditions that can be negotiated between parties and incorporated into the Note. Here are the most common:
- Late charge – a certain amount or percentage of monthly payment is due if paid late
- Due on Sale clause – the loan must be paid in full if property transfers ownership
- Prepayment penalty – penalty to be paid if loan is paid off early
- Subordination clause – allows this loan to be subordinated to a new loan to be made in the future
There are many variables, requirements and conditions to consider for each Note and for each clause to put in it. One error may invalidate part of the Note or even the whole, and may not be caught until years down the line at a crucial moment. The preparation of a Note requires knowledge of the section of laws that govern it. Depending on the type of transaction and property, the laws can be found either in the California Business and Professions Code or the Civil Code. Escrow Officers may prepare the Note but it is up to the client to obtain their own independent legal counsel to review the Note and make sure that it properly reflects the agreement and will stand up in a court of law.
A couple of the Note forms can be found on our website under our Forms section. It is important that you seek your own independent legal and financial counsel with respect to all conditions and preparation of the Note in and outside of an escrow transaction.
Next question: “What is a Deed of Trust?”
FAQs
The deed of trust is what secures the promissory note. The promissory note includes the interest rate, the payment amounts and terms, and the buyer's promise to pay the lender the amount borrowed plus interest.
Are deed and note the same thing? ›
To Recap: The Deed is a recorded document memorializing the transfer of property from the Grantor to the Grantee. The Note is an unrecorded paper that binds an individual who has assumed debt through a promise-to-pay instrument.
What is the purpose of the deed of trust? ›
A deed of trust is a document used in real estate transactions. It represents an agreement between the borrower and a lender to have the property held in trust by a neutral and independent third party until the loan is paid off.
What is the disadvantage of a deed of trust? ›
Disadvantages of a Trust Deed
For borrowers, if financial circ*mstances change, default on repayment can result in property foreclosure. Late payments should be avoided to prevent escalation and property loss. An asset-based loan can increase financing access but doesn't increase your capacity to sustain debt.
How is a promissory note secured with a deed of trust? ›
Once the promissory note is signed and the loan is enacted, the deed of trust is held by the third party trustee until the loan is entirely paid off. Once the loan is satisfied, the deed of trust is transferred to the borrower. The promissory note, meanwhile, is held by the lender until the loan is satisfied.
Is a note a deed of trust? ›
The property owner signs the note, which is a written promise to repay the borrowed money. A trust deed gives the third-party “trustee” (usually a title company or real estate broker) legal ownership of the property.
What is a note on a property? ›
A mortgage note is a legal document signed when closing on a mortgage. The mortgage note contains details about a loan, including interest, monthly payments, and penalties for late payments. 1. The mortgage note establishes the property as collateral for the loan.
What is a deed of trust for dummies? ›
A deed of trust has a borrower, lender and a “trustee.” The trustee is a neutral third party that holds the title to a property until the loan is completely paid off by the borrower. In most cases, the trustee is an escrow If you don't repay your loan, the escrow company's attorney must begin the foreclosure process.
Does a promissory note need to be recorded? ›
Recording a promissory note is not required by law in most cases, but it can serve as proof of the debt and provide a public record of the obligation. Recording a promissory note can also protect the lender's interest in case the borrower sells the property or takes out another loan against it.
What makes a promissory note invalid? ›
A promissory note can become invalid if it lacks essential elements, such as the borrower's signature, the principal amount, and the repayment terms. Invalidity may also result from non-compliance with legal requirements or if the note was created under duress or fraudulently.
Asset protection: A properly designed trust can also protect the assets in it from creditors, predators and failed marriages. In addition, a properly designed trust can protect the assets in it from long-term care and nursing home costs.
What are the disadvantages of putting your house in a living trust? ›
Disadvantages of putting a house in trust
- Expense. Creating and maintaining a trust is typically more expensive than creating a will.
- Loss of control. If you create an irrevocable trust, you typically cannot change the terms of the trust or change the beneficiaries. ...
- Other assets may still be subject to probate.
Trustees may petition the court for you to enter into sequestration. Your fees and interest will become unfrozen. Creditors may lose faith in your ability to pay and petition the court for sequestration, or for wage arrestment or another court order.
When a borrower signs a note and deed of trust who gets a security interest in the property? ›
With a mortgage or deed of trust, you give the lender a security interest in the home—that is, the home becomes collateral for the loan. The lender records the mortgage or deed of trust in the land records to create a lien on the property.
Who holds the promissory note in real estate? ›
The lender will keep the original promissory note until the loan is paid off. There may be some circ*mstances, such as during a refinance, where the loan terms (and therefore, the promissory note terms) change and you will likely be issued a new document to sign.
Can you put a promissory note in a trust? ›
Promissory note planning often occurs in conjunction with irrevocable grantor trusts. Grantor trust status can be achieved by allowing the grantor of an irrevocable trust to exchange trust-owned assets for personally owned assets of equivalent value.
Is a security deed the same as a note? ›
The Note is signed by the people who agree to pay the debt (the people that will be making the mortgage payments). The Deed and the Deed of Trust are signed by those who will own the property that is being mortgaged.
Is a warranty deed the same as a note? ›
A note is a loan, i.e. promissory note. A deed is a registered title. A warranty deed or a quit-claim deed. In California, there is a “Deed of Trust” which gives a secured lender the right to foreclose on real property (land or house) based on a promissory note (mortgage).
What does it mean to hold the note on a property? ›
Under a holding mortgage agreement, the homeowner acts as a lender to the home buyer, offering them a loan to finance their purchase. The buyer makes monthly payments to the seller, who retains the property title until the loan has been paid in full. Most holding mortgages are short-term and may not be amortized.
What is the difference between a promissory note and a contract for deed? ›
Example: When used in a real estate transaction, the promissory note covers the promise to repay the amount owed, interest, and maturity date — while the deed of trust or mortgage outlines the other responsibilities of the parties involved more precisely.
