Many people take out loans to purchase a home and do not truly understand the difference between a promissory note vs. a mortgage. Below we outline what each means, their differences, and why this is important.
Promissory Note Vs. Mortgage
A promissory note is a document between the lender and the borrower in which the borrower promises to pay back the lender, it is a separate contract from the mortgage. The mortgage is a legal document that ties or "secures" a piece of real estate to an obligation to repay money.
The mortgage itself does not obligate anyone to repay money. If a person's name is on the mortgage to a piece of property, then that person may not be required to repay the loan. The mortgage does not create personal liability. We determine who is obligated to repay the loan by looking at the promissory note.
Who Is Obligated to Repay?
Only those who sign the promissory note are required to repay the money lent under the promissory note. If a married couple takes out a loan in the husband's name, then most lenders will require that the wife be named in the mortgage. So long as only the husband signs the promissory note, the wife has no personal obligation to repay the loan. This is a critical distinction and is often misunderstood. The fewer people on the promissory note is almost always better for the borrowing side of the transaction.
Here is another example:
- Karl purchased a home in Oswego, Illinois on August 1, 2006. In order to finance the purchase, he went to Local Prairie Bank to obtain a home loan. The selling price for the home was $300,000. Karl had $60,000 saved as a down payment. Local Prairie Bank lent Karl $240,000 at 7% interest to be paid off over 30 years. At the real estate closing, Karl signed a promissory note. This note represented Karl's personal promise to repay the $240,000, and also set forth the terms of the loan. Karl also signed a mortgage.
- The mortgage incorporated the terms of Karl's promissory note, and secured the value of the promissory note against the value of Karl's new home. This means that if Karl fails to make the scheduled loan payments, the bank can initiate foreclosure proceedings against Karl's house. The bank could also directly pursue Karl for the balance of the loan based on the terms of the promissory note. The seller, Sam, executed and delivered to Karl a general warranty deed, which vested title in the property in Karl. After the closing, the title company recorded the Sam-to-Karl deed with the Kendall County Recorder of Deeds.
- Shortly thereafter, Local Prairie Bank recorded its mortgage with the Kendall County Recorder of Deeds. Local Prairie Bank's mortgage functions as a lien against Karl's property. If Karl attempts to re-sell his property to someone else, a title search will reveal that Local Prairie Bank has an outstanding mortgage on the property. This way, the public is on notice that Karl owns the property, and that the property is subject to Local Prairie Bank's lien interest. Once Karl pays off his loan, Local Prairie Bank, or the owner of the loan at that point in time, will record a release of mortgage with the Kendall County Recorder of Deeds. This document will release the mortgage lien on Karl's house. At all times after the closing, Karl is the title owner of his home.
Creditors (Banks) will typically want as many people on the note as possible to allow them more people or entities to go after if there ever were a default in the future. The individual or individuals who signed the promissory note are personally liable for the money that was borrowed and can be sued personally and have their assets seized, credit report negatively impacted and their wages garnished of lack of payment. Those who signed the mortgage only and not the promissory note are immune from asset seizure, credit report impairment and wage garnishment.