Buying a house or any other property is a daunting journey for salaried or low-income individuals. The expense of rent, children education, utilities, and healthcare make it difficult to spare money and purchase a property which one could call “home.” For these individuals, purchasing a home feel like a challenging task, leading them to explore alternatives like loans or mortgages.

Property investors are also no different. They also face situations where they find a perfect property for the investment but unfortunately, they don’t have enough money to purchase it. They approach friends or other investors to borrow loans that help them buy a property. So, whenever people handle a loan transaction, a question is normally asked: what is a promissory note and how does it work in property deals?

In this blog, you’ll explore the definition, purpose, and legal aspects of promissory notes and discover how does it play a vital role in real estate deals.

Need guidance to buy or sell properties? Contact Redhead Home Properties to explore affordable housing options and get personalized selling advice.

Promissory Note: What You Need to Know?

In simple terms, a promissory note is a written pact that a borrower makes to pay the lender a specific amount of money, either on a set date or over time, mostly with interest. Let’s make it clear by a simple example.

General Example:

Suppose you borrow $60,000 from your friend David to buy a car.

• Both you and David agree that you will pay back the amount in 24 monthly installments, including interest.
• You write down all the agreement terms, sign it, and David signs it too. That document is the promissory note.

How is Promissory Note Used in Real Estate?

Scenario 1: Bank Financing

When you don’t have enough money to buy a house, you visit banking institutions to learn about their loan products. You choose a plan for yourself and then agree to pay back the amount as per their defined terms.

When a buyer obtains a mortgage loan from a bank to purchase a property, they need to sign two key documents: promissory note and mortgage or deed of trust.

A promissory note is the promise to repay the loan, including terms and conditions. However, mortgage or deed of trust gives the lender the right to confiscate the property if borrower is unable to pay back the loan.

Example:

You want to buy a $200,000 house and the bank lends you $140,000.

• The promissory note says that you will pay back the amount of $140,000, plus 4% interest over 5 years, with monthly installments of $2,578.31.
• Mortgage documents tell that if you don’t pay, the bank has the right to foreclose on your home.

Scenario 2: Seller Financing

Have you ever witnessed housing schemes which offer fully developed homes on installment? This type of financing is similar where the seller acts as a bank and offers an installment plan, allowing you to pay the amount over a certain period. In such cases, you need to pay some amount upfront. The seller allows you to pay the rest of the amount in easy installments.

Example:

The seller or housing agent is selling a house for $200,000. The buyer pays $50,000 down payment and signs a promissory note to pay the remaining $150,000 over 5 years with 4% interest.

Scenario 3: Real Estate Investing

Sometimes investors are short of money, and they borrow it from other investors to buy or renovate a property.

Example:

An investor lends $50,000 to another investor for a year at 10% interest.

• What is a promissory note for this scenario? It explains that borrower will pay $55,000 by Aug 5, 2026.

What are the Key Terms of a Promissory Note?

The promissory note contains the complete details of the loan that includes:

• Loan Amount:You need to mention the total amount borrowed.
• Interest Rate: Define the percentage charged on the loan, such as 5% or 6%.
• Payment Plan: It’s compulsory to mention how and when the loan will be repaid, i.e., monthly or quarterly installments.
• Loan Maturity Date: It is the date on which the loan will be fully repaid.
• Collateral: Mention the assets which the borrower wants to keep as a security in case of default.

Legal Aspects of a Promissory Note

A promissory note is a legally binding written promise for debt repayment. It is the evidence of the debt and provides legal recourse for the lender in case the borrower is unable to pay back. Here are some of the legal aspects which you need to know:

• Enforceability: If the promissory notes are in writing, they are enforceable in the court of law. But always ensure that terms are written clearly, signed by the borrower, and compliant with all applicable laws.
• Contractual Obligation: When a promissory note is signed by both parties, it binds them in an agreement and each party must abide by its terms.
• Legal Recourse: If a promissory note is written as per the defined criteria, it gives the lender the right to pursue legal action to recover the debt.
• Transferability: If you have lent money to someone and borrowed it from another party. If the amount is the same, you can transfer it to the third party, allowing the lender to sell the debt.

Important Tip: You need not write vague terms, never include complex details, avoid unsecured notes, as well as ensure that terms of promissory note are fully compliant with specific laws of the state.

Importance of a Promissory Note for Real Estate

There are several benefits of writing a promissory note which are as follows:

• Legal Protection: If the borrower defaults, a promissory note gives the lender the right to take legal action.
• Reduces Misunderstanding:When you clearly outline the loan amount, repayment schedule, interest rate, and other key terms, it minimizes confusion and creates confidence.
• Recordkeeping: A promissory note serves as a valuable financial record for both borrower and lender. It helps in handling the accounting and tax procedures.
• Flexibility:It provides a balance between informal and formal loan agreements, ensuring flexibility in multiple lending scenarios.

Still confused? Reach out to Redhead Home Properties, as our expert team is ready to guide you through writing promissory notes and handling property transactions with confidence.

Final Words

Here we are with the same question: what is a promissory note? Remember, it’s a legally binding written promise stating that the borrower will pay back the loan amount plus interest rate by a defined time. It gives the lender legal protection and mitigates the risk of the borrower not paying the full amount that was agreed to by both parties. However, if you are a first timer you should consult the real estate experts, such as Redhead Home Properties, to avoid issues associated with promissory notes.

Frequently Asked Questions

What is a Promissory note?

A promissory note is a written promise that a borrower makes to pay back the loan amount within a specified time, including interest rate.

What are the risks of using a promissory note?

A promissory note lacks the legal framework of more formal loan agreements which are required for financial dealings. However, if it is written as per law and with clarity, it could serve as evidence to contest your case in court.

Is promissory note powerful?

The written form of promissory notes is much more powerful compared to the verbal form. It gives the lender the right to take legal action against the borrower who is unable to pay back debt.

How long is a promissory note valid?

The validity of a promissory note depends on which state you live in and remains tied to the statutes of limitations for debt collection. In California and Texas, the validity period is 4 years from the date of default for written contracts, while in New York the limit is 6 years and Ohio, 8 years.