Detailing Documents – Promissory Notes vs Mortgages and Deeds of Trust

Can you judge a document by its cover?

We talk a lot about getting all your ducks in a row when purchasing notes. Only by doing your homework and really looking at a deal can you decide if it fits your investing goals.

And one thing you look at are the documents.

When an individual agrees to owner finance their property, they become the bank. While in traditional bank financing, our brains always go to “mortgage,” that’s not always the case.

Let’s break that down.

Promissory Notes vs Mortgages or Trust Deeds — and Where Do Contract for Deeds Come in?

One of the great things about seller financing is that it offers home buyers, home sellers, and note investors creativity and, therefore, opportunity. However, that doesn’t mean it’s a free-for-all. Each state has its own set of rules that must be followed, including what type of documentation is required.

Promissory Notes

At its most basic level, a promissory note is an IOU. It states that the borrower (the property buyer) promises to pay the seller a certain amount. However, when you examine it more closely, it goes much deeper.

Terms outlined in the promissory note include:

• Borrower (also called the payor or maker)
• property serving as collateral
• loan amount
• payment amount and frequency
• interest rate
• note term (length of time for repayment)
• all due date or maturity date
• balloon amount and date, if applicable
• late fees and penalties

The Seller (now the Lender) holds on to the promissory note until that obligation is paid in full, at which point it is marked “paid in full.” Unlike with a Mortgage or Deed of Trust, it isn’t typically recorded with the county (the exception being a few states, like Florida).

Mortgages vs Deeds of Trust

While the promissory note lays out the agreed-upon terms, a mortgage or deed of trust is the security. This document establishes your lien position against the pledged real estate (the collateral). It also contains a clause allowing the lender to demand payment if in default and the right to foreclose and take the property back if payment isn’t made.

The question is: does it matter if you use a Mortgage or Deed of Trust?

The terms judicial versus non-judicial states come up when comparing these documents. A mortgage is utilized for those creating notes in judicial states.

In non-judicial states, a deed of trust is used. Non-judicial foreclosures involving a deed of trust are generally quicker and less expensive than judicial foreclosures. In addition to the Borrower and the Lender, the Deed of Trust adds a third party trustee to the mix.

A state normally prefers one or the other, but a few states give you the option of using either a Mortgage or a Deed of Trust. (As always, check with an attorney to verify documents legally binding in your state). The Mortgage or Deed of Trust is recorded in the county where the property is located.  When the note is paid in full then a satisfaction, release of lien, or reconveyance is recorded.

Contracts for Deed

But wait, there’s more!

Enter Land Contracts and Contracts for Deed or CFD for short. The CFD is an alternative way to document the seller financing arrangement from the more common Note and Mortgage or Note and Deed of Trust.

Contracts for deeds do not require promissory notes as they detail the repayment terms within the contract (although we’ve seen them used together).

One big consideration with Contracts for Deed is the buyer will not receive the Warranty Deed to the property until the purchase price is paid in full. That means the seller stays in control as official fee simple title holder while the buyer makes payments. Think of the contract like a layaway program for the Deed.

So, why aren’t Contract for Deeds always used? Well, they can be tricky. Each state treats them differently. Property buyers want to avoid the challenges that come with the seller keeping the title. Additionally, after many updates in financing laws, investors generally prefer documents that look like what the banks use and prefer the note and mortgage or deed of trust strategy.

What Happens When You Buy a Note and Mortgage?

You don’t create a new note and mortgage with new names and signatures — you have to transfer the existing originals.

For the promissory note, that is a note endorsement. The note seller signs over their right to collect on the debt to the note buyer (similar to endorsing a check). The endorsement either goes on the original note itself or an allonge is created and attached.

The assignment of the mortgage or assignment of the deed of trust transfers the lien rights against the real estate to the note investor. The assignment is then recorded in the same county as the original mortgage or deed of trust.

The note buyer holds the original promissory note along with the endorsements or allonges until the note is paid in full and the lien is released.

It’s a Document Combination

When it comes to investing in notes — it’s not just one document you need to review and eventually take over. It’s typically two, with the promissory note laying out the terms and the mortgage or deed of trust securing that promise to pay with a lien on the property.

Additional Seller Financing Resources

• Creating Notes Master Class
• Stop Doing This When Offering Owner Financing
• Researching the Note Deal – The Steps Before the Offer
• Note Investing 101 Series
• 21 Tips to Read Before Investing in Notes
• 300+ Free Articles on Real Estate Notes, Note Investing and Seller Financing
• Check Out All of Our Master Classes