When you take out a home loan, the lender will probably require you to sign both a promissory note and a mortgage. These documents set up the terms of the loan and have the same goal: to make sure the lender gets repaid. But the documents take different routes to get to this goal.
With a promissory note, you promise to make periodic payments to repay the amount you’ve borrowed. With a mortgage, you give the lender a way to get its money back if you don’t keep your promise to make those payments—through a foreclosure.
The Promissory Note: Like an IOU
The contract a borrower signs with a lender in order to borrow money is called a promissory note.
A promissory note is basically an IOU—a signed agreement to repay money—from a borrower to a lender. The promissory note has language saying that the borrower promises to repay the loaned money and includes the terms for repayment. For example, a typical promissory note will specify:
- the total amount of the loan
- the interest rate
- the amount that the borrower must pay to the lender each period (usually each month)
- the late charge if the borrower doesn’t make payments on time, and
- how long the borrower gets to repay the loan.
If you make all of the required payments and completely pay off the loan—which normally happens after many years—the lender marks the promissory note as “paid in full” and gives it back to you. If you don’t make the payments, the lender still has a way to get repaid: by using the mortgage to foreclose on your home.
The Mortgage: Giving the Power to Foreclose
Again, while the promissory note contains your promise to repay the loan, the mortgage describes what happens if you fail to keep that promise.
By signing a mortgage, you put the title to the home up as security—collateral—for the loan. If you don’t make the loan payments, the mortgage allows the lender to sell your home through a process called foreclosure and use the proceeds from the sale to recoup its money.
A mortgage also sets out your responsibilities for taking care of the property. A mortgage usually requires you to:
- keep the home in good shape
- refrain from storing hazardous substances on the property
- have homeowners’ insurance for the property, and
- pay the property taxes.
Lenders want borrowers to take care of these responsibilities because of the possibility of eventual foreclosure. A house that doesn’t have property tax liens and is in good condition will bring in more money at a foreclosure sale than one burdened with liens and left in disrepair.
If you’re taking out a home loan and need help understanding the terms and conditions, consider talking to a real estate attorney before signing the paperwork. If you’re worried about a possible foreclosure, consider talking to a foreclosure attorney.