When real estate is purchased, that purchase is either through a cash sale or with the help of borrowed funds. If it is purchased with the help of borrowed funds, a mortgage note will be created.
There are two parts to any mortgage note: They are…
- The Promissory Note: This is a legal instrument which obligates the borrower to repay the loan
- The Mortgage: This document secures the real property as collateral for the loan
The Promissory Note
The promissory note binds the the buyer for repayment of the loan. It is nothing more or nothing less than a simple agreement to repay a loan. In real estate, it is a contract between the buyer of the property (known as the mortgagor) and the lender of funds (known as the mortgagee).
The promissory note will set forth the terms of the loan such as the:
- names of the parties (mortgagee / mortgagor) entering into the agreement
- interest rate on the borrowed funds
- payment terms (monthly, quarterly, annually, etc.)
- maturity (when the loan must be repaid in full)
- events of default, penalties, and remedies
The mortgage guarantees the loan and ties ownership of the real estate to timely payments on the promissory note. If the borrower does make payments on the loan, the lender may take title to the property through a process called foreclosure.
- secures the promissory note as collateral
- defines the collateral which is subject to foreclosure in the event of default
Mortgage Loan Interest Structures
While there are many “types” of mortgages and mortgage loans, there are basically only two interest structures related to mortgage loans. Th
- Fixed Rate Mortgage Loans: The interest rate charged by the lender on the loan remains the same or “fixed” for the entire life of the loan. In a standard “amortized” mortgage loan, the amount of the monthly payment will always remain the same.
- Adjustable Rate Mortgage Loans: The interest rate charged by the lender changes periodically based on an “index”. This index can be the prime rate of interest, LIBOR rate, or can be indexed to U.S. Treasury bond / note rates such as the 10 year Treasury Note. The total interest rate charged to the borrower on an adjustable rate mortgage is the index rate plus a margin rate. The margin rate is the add-on which represent the loan profit to the lender.
Categories of Mortgage Notes
There are basically three (3) categories of mortgage notes.
- Residential Notes: single family homes, townhouses, condominiums, duplexes, triplexes, etc.
- Commercial Notes: retail space, offices, apartment buildings (more than 4 units), industrial properties
- Vacant Land Notes: land not designated for a specific use, farmland, unimproved land