Defining a basic word like “mortgage note” to a group of real estate folks may seem a little silly. Many of us know the Wikipedia definition that “a mortgage note is a promissory note associated with a specified mortgage loan; it is a written promise to repay a specified sum of money plus interest at a specified rate and length of time to fulfill the promise.” In essence, it is an IOU. We know that a mortgage note can also be called a real estate note, a deed of trust note, or a real estate lien note. When accompanied by a mortgage or deed of trust that collateralizes the property, it is sometimes written as an installment note, a promissory note, or just a simple note. Since readers have a wide variety of expertise and experience, my hope is that some of you will learn while others may appreciate being reminded of the basics of the mortgage note.
Why Create a Mortgage Note?
A common misconception even among those familiar with the business is that a mortgage note is created only when the buyer of a property has lousy credit and is “unbankable.” While that is sometimes the case, there are a number of other reasons why a buyer and seller of a property use owner financing to create a real estate note. Perhaps the property is non-conforming, the parties wanted unique terms on the note, they wanted to close more quickly, the seller wanted to collect the payments, or any number of other reasons.
Creating an owner-finance transaction should not be a do-it-yourself adventure. The parties, especially the seller, should not skimp on using a title company or attorney to prepare the documents, manage the closing, and record the deed. If the documents are not correctly done and the rules followed, the property seller may find that he or she is holding little more than near-worthless pieces of paper. The note must clearly state the terms, while the trust deed or mortgage clearly show the specific property.
Mortgage Note Maintenance
So, the transaction has completed and the proper documents filed or recorded. Now, the note holder can kick back and wait for the monthly payments to automatically roll in, right? Well, no – this is not like holding a bank CD or savings account. The holder of the real estate note still needs to make sure that payments are timely, that proper insurance is maintained (with the note holder as a beneficiary on the policy), and that property taxes are kept current. The best case scenario for the note holder is that the payer makes on-time payments for the life of the note until the balance is fully extinguished. In less perfect situations, the payer will make late payments or miss some entirely, won’t maintain the property, or will not keep up on the taxes and insurance. The note holder should know ahead of time his or her rights and obligations.
Next time, we’ll cover how to structure a note to best protect both parties and to make it marketable. On the latter point, even though the seller may originally plan to hold the note for a full term, circumstances may change such that the person later wants to sell all or part of the note.