The difference between a promissory note and a mortgage is that the former is an agreement stating a borrower’s promise to repay the debt to a lender, whereas the latter is the document allowing lenders to put a lien on the borrower’s property.
Read on for a full promissory note vs. mortgage comparison that includes the definition of both terms, their key differences, and some useful tips on how to create and use these documents.
What Is a Promissory Note?
A promissory note is an official contract in which the borrower promises to pay off the loan amount to the lender. This is a legally binding document, and parties often use it to formalize loan contract agreements.
The essential promissory note elements include:
Promissory Notes Elements
Information about the parties involved (full names, addresses, contact details, etc.)
Loan amount and interest rate
Repayment terms
Maturity dates
Potential penalties if the borrower defaults on payment
There are two main types of promissory notes—secured and unsecured. Secured notes contain property collateral, such as a car, house, or other valuable asset.
The unsecured promissory note definition refers to a legal document solely based on the borrower’s promise to repay the debt, as there’s no collateral. Specifically, if the borrower fails to make payments on the agreed-upon time, the lender’s only option is to pursue other legal action, such as filing a claim in small claims court, to recover the debt.
You can use a promissory note for personal loans, as well as student, business, and real estate ones (e.g., to formalize home loan agreements). It obliges borrowers to repay the debt and stipulates how exactly they must do so, which means there’s little to no room for misunderstandings and possible disputes.
On the other hand, if you’re wondering what makes a promissory note invalid, it’s usually the lack of stipulations (repayment terms, dates, etc.), vague language, and non-compliance with the usury laws (maximum interest rates).
What Is a Mortgage?
A mortgage is a loan agreement that allows the lender to place a lien on the borrower’s property and sell it if the borrower fails to repay the debt.
This document features:
Mortgage Elements
Information about the lender and the borrower
Property information, such as the borrower’s title to it and the registered number
The loan term or the maturity date
Possible risky features (balloon loan, negative amortization, prepayment penalty, interest-only feature, etc.)
Loan-closing costs, including the lender’s fees
There are similar legal agreements for loans, such as deeds of trust. While such documents are also loan security documents, they are slightly different from mortgages. Precisely, a deed of trust involves at least three parties, one of whom is the trustee, who holds the property in trust for the lender.
Besides the difference between promissory notes and loan agreements, there are distinctions between mortgages vs. loan agreements.
Namely, loan agreements are comprehensive documents that fully outline the loan relationship between the lender and the borrower. They can be considered a more comprehensive version of promissory notes, whereas mortgages focus only on the borrower’s property and its acquisition in default cases.
4 Key Differences Between a Promissory Note vs. Mortgage
The promissory note vs. mortgage comparison shows key differences regarding their use and the legal rights they imply.
Let’s see what the four main differences between these two documents are:
Promissory Note vs. Mortgage Differences
#1. Purpose
The promissory notes vs. mortgages comparison indicates that these documents do not serve the same purpose. You use the former to make loans and establish clarity and accountability by stating the repayment terms, deadlines, interest rates, and potential penalties. Such documents primarily focus on loan repayment, regardless of how the borrower will repay it.
On the other hand, mortgages identify and state collateral. Regardless of the loan amount, they guarantee that the lender can seize the defined collateral in case of a default and use it to reclaim a part of or the full loan sum.
#2. Enforcement
The second element in our promissory note vs. mortgage comparison shows that if you use an unsecured promissory note, you have no right to the borrower’s piece of property. This means that you can seek restitution in small claims court.
In contrast, if a term loan or any other type of loan includes signing a mortgage, you will be able to enforce such a contract much easier due to having the right to take and sell the borrower’s asset or property.
#3. Risk and Liability
By signing promissory notes and mortgages, you take different risks and duties. For instance, an unsecured promissory note bears the risk of your loan not being repaid, as it is more challenging to enforce due to its lack of collateral. Meanwhile, enforcing a mortgage is less risky because collateral is outlined.
If you only sign a mortgage, you are obligated to let the lender take it and sell it if you default on payments. In other words, you will not be responsible for repaying the full debt if the collateral value does not cover the whole loan amount.
On the contrary, signing a promissory note will mean you must pay the total loan in any way, with or without interest rates. Therefore, if the lender seizes the collateral, sells it, and more money is still needed to repay the debt, you must make additional payments.
#4. Document Possession
The final key promissory note vs. mortgage difference relates to the legal document holder. Namely, the lender who signs a promissory note with the borrower is entitled to this contract. Only after the borrower pays off the debt in full is the lender required to give the note to the borrower and consider the loan repaid.
However, with a mortgage, neither party can keep the document, as it becomes part of the county land records and serves as a trace of ownership.
When Is a Promissory Note Used?
A promissory note is used to establish a relationship between the lender and the borrower for business, student, real estate, and, primarily, personal loans. Depending on the level of trust and the borrower’s credit score, the lender can make smaller or larger loans.
As with using quitclaim deeds to sell properties to trusted parties, you may also use unsecured promissory notes to make loans; still, using this type usually exhibits higher interest rates.
You can also make personal loans using secured promissory notes. This type of note is more suitable for real estate loans, as it plays a significant role in buying properties such as houses and making balloon or other types of payments.
Finally, promissory notes are a good way to make student loans. The lender can validate the repayment process and make it easier by offering payment plans such as installment payments.
When Is a Mortgage Used?
A mortgage is used to buy houses or similar property, which the lender can seize if the borrower cannot pay off the debt. Alternatively, the lender can seize a house the borrower already owns if the borrower lends the money for any purpose but fails to repay it.
Most commonly, borrowers sign a mortgage if they have insufficient funds to buy a house or similar property. This means they will receive money to buy the house minus what they already have.
Generally, borrowers make payments in installments, also known as mortgage payments, until the maturity date. These are typically monthly payments that include both the principal and interest rate.
Additionally, they may need a loan for purposes other than house purchase. If so, they can take the loan and use a mortgage to put a lien on their house, whose worth is equal to or similar to the loan amount.
Sometimes, the collateral value can be higher than the loan amount, in which case the lender can sell the property, cover the debt, and return what’s left to the borrower.
Can a Promissory Note Be Used Without a Mortgage and Vice Versa?
A promissory note can be used without a mortgage and vice versa, but this may seriously affect the enforceability of these documents.
As already discussed, promissory notes without a mortgage count as unsecured notes and are based only on the borrower’s promise for repayments. Without collateral, lenders may have a hard time enforcing notes, as they can send a demand letter or reach out to small claims court, which is a costly and lengthy process with no guarantee of succeeding.
Similarly, a mortgage without a promissory note only obliges borrowers to relinquish their property if they cannot repay the debt. Yet, this does not mean that borrowers must pay the entire debt, which can exceed the collateral value.
So, despite the promissory note vs. mortgage differences, we highly recommend signing both documents when making any type of loan.
How to Secure Loans With Minimal Effort Thanks to Contracts.net
To secure loans with Contracts.net, you can use our promissory note templates and create valid documents of this type. They are made according to the general and state-specific rules, which means you can simply fill them out with the necessary personal information and get a fully customized and legally binding document.
Moreover, you can also generate other documents related to real estate transactions (e.g., a quitclaim deed to avoid formalities when transferring property, bills of sale, or purchase agreements). Due to their simplicity, all our tools are rather user-friendly and easy to navigate, so all you need to do is follow simple instructions on the screen and get all the necessary documents within minutes!
Final Thoughts
The promissory note vs. mortgage difference teaches us that both documents are crucial for securing loans. Promissory notes can formalize loan agreements and establish clarity for the entire loan repayment process. Mortgages, on the other hand, allow lenders to place a lien on borrowers’ property and sell it if they default on payments.
For full loan security, parties should use both documents in conjunction. Websites like Contracts.net can help them prepare the documents as well as get information on how to use them.
Promissory Note vs. Mortgage FAQ
Yes, you need a mortgage if you have a promissory note because mortgages include collateral, which is property or an asset you can take in case of a borrower’s default. Without a mortgage, it may be challenging to enforce a promissory note.
If you default on a mortgage or promissory note, the lender will be able to seize the collateral defined in the agreement. Defaulting on unsecured notes that do not include a mortgage will also lead to legal consequences (e.g., being sued by the lender in small claims court).
Yes, promissory notes and mortgages are legally binding. Still, issuers must meet all the requirements (e.g., inclusion of repayment terms, maturity dates, etc.) during the creation process to make them valid.
When the lender dies, the borrower will still be obliged to pay the debt specified in the promissory note unless stated otherwise.
