What Is A Mortgage And A Promissory Note?

If someone were to ask you how a mortgage works and what is a promissory note, would you know how to explain it to them? As a newbie, I struggled with these concepts because I never took the time to understand the details. If you’re in the same boat, we will fix that today!

First and foremost, both promissory notes and mortgages are nothing more than legal documents, aka contracts!

They’re documents that spell out on paper the terms of a loan that you use to purchase that next investment property, or any other property for that matter.

Let’s take a closer look.

The Promissory Note

Think of a promissory note as exactly what it sounds like: a promise. This note is a promise you make to your lender that you will pay the loan back by a certain amount of time with a certain amount of interest. That’s it!

A note has the terms of repayment outlined in it like the total loan amount, interest rate, monthly payment amount, late charges, how long the borrower has to repay the loan, etc.

Pretty simple so far.

Now promising to repay a loan is great and all but do you really think the bank will just take your word for it? Ha!

This is where the mortgage comes in: it describes what will happen if you fail to repay the loan.

"A promissory note is your promise to repay the loan. A mortgage describes what happens if you don’t keep that promise."

The Mortgage

The mortgage contract states that if you don’t repay the loan following the terms defined in the promissory note, the lender has the right to take your property and sell it to pay back what you owe.

It’s the lender’s way to secure the loan. In fact if you read a mortgage contract, you’ll often see the mortgage referred to as the “Security Instrument”.

The way the lender secures the loan depends on what state you live in. The lender will either take title of your property after you close on it, or place a lien on it. In either case, the bottom line is if you don’t make your payments, the lender will exercise its rights defined in the mortgage to take your property.

Once you pay off your loan in full, the title goes back to you or the lien is removed from your property and you’re in the clear!

One thing to note. I often hear someone saying “I took out a mortgage to buy X property”. This led me to believe that the mortgage was the actual loan itself. But it’s not! As we stated above, the mortgage is a component of the entire mortgage loan process which secures the loan for the lender.

To sum it all up, here's an illustration I made:

In Conclusion

A promissory note is nothing more than a promise you make to your lender to make regular payments to repay the amount you’ve borrowed at the agreed upon terms.

A mortgage is nothing more than a defined way for the lender to get its money back if you don’t make those payments.

There you have it! Hope that helps to clear things up.