A Little About Promissory Notes
When someone borrows money, he can agree to repay the loan and shake hands with the guy who lent him the money, or he can sign a piece of paper. The piece of paper is a Note (often called a Promissory Note), which is just a promise to repay, like an IOU. It usually says things like, “Yes, I know this money is supposed to be repaid” (in other words, this isn’t a gift), and “Yes, I agree to pay you back before the cows come home.”
If the borrower fails to do what he promises to do in the Note, the lender must go to court to enforce the debt. In court, the lender not only has to prove (1) that the borrower agreed to repay the money (this is why it is important to have a Promissory Note instead of just taking the guy’s word . . . and his handshake), the lender also has to prove (2) how much money is supposed to be repaid.
And, then, once the lender has a Final Judgment, saying that the guy really does owe him $xxxx, the lender usually has to go BACK to court to enforce the Judgment. Enforcing the judgment means the lender has to ask the court for permission to go get something owned by the borrower that’s worth the same as the amount of money owed. What a hassle! It would be much easier if the lender already took something owned by the borrower in the beginning instead of having to go to court to ask for something later.
So, when a creditor is not sure that a borrower will pay back a loan, the creditor will ask for “security” from the borrower. This is the lender’s very own “security blanket” – just in case the borrower does not repay the loan (as if that would ever happen ).
The security can be anything – it can be someone’s watch, or a car or a boat, or some other type of personal property owned by the borrower. Or, it can be a piece of real estate. If the creditor has some of the borrower’s property as “security,” the lender can then take that property and sell it if the borrower does not repay the debt. All the rules about how, when, where, why, and if the creditor can sell the property depend on what type of “security” is involved and where the property is located.
Be sure to hire a real estate attorney who knows the laws in your area because the laws and procedures are very different depending upon where you and/or the security is located.
As mentioned earlier, a Note is often called a Promissory Note because it contains the borrower’s promise to repay the borrowed funds.
Here are the basics.
The Person Who Promises to Repay the Debt
In the Note document, you might see different words describing the person who promises to repay the debt. He might be called the Maker. Or, he might be called the Borrower – the person who borrows the money. Borrower also implies that the money is supposed to be repaid; i.e. that it’s not a gift.
The person who promises to repay the debt might also be called the Payor – the person who has to pay!
The person who borrows the money and promises to repay is not necessarily the person who gets to use the money. There can be a difference between the person who gets the benefit of the money and the person who agrees to repay the debt. So, a fourth term you might see is Obligor, meaning the person who is “obligated” to repay the funds.
For example, what if a 20-year old wants to borrow money to buy a house? But the lender thinks (rightly so) that the kid doesn’t make enough money from his job to repay the debt. So, the lender might request that the kid’s parents also sign the Note so that, if their son does not repay the money, the parents will be on the hook. In this case, the parents would be Obligors, but not see a dime of that money.
You may also hear of something called a Guaranty, which is a separate piece of paper, different than the Note but the same basic idea. In the previous situation, the lender might ask the parents to sign the Note and become Obligors, or the lender might ask the parents to sign a Guaranty, saying that if their son does not repay the loan, then the parents will step in and pay. A Guaranty is often used when a business borrows money; the lender may require an individual, such as an officer or an owner of the company, to guaranty that the company will repay the loan.
NOTE: You may see Guaranty spelled Guarantee – some commentators think there is a distinct difference, but the two spellings are often used to mean the same thing in today’s documents.
The Person Who Receives the Debt Payments
So, now that you know who the Payor is, you can figure out who is supposed to receive the money – the Payee! The Payee might also be called the Obligee or the Lender. For some reason, we don’t call the Lender a Makee . . . (don’t ask, I don’t know).
The person who receives the debt payments is usually the person who gave the money in the first place. But it could also be someone else – an Assignee of the original lender. I will adress Mortgage Assignees in a later post.
Terms in a Promissory Note
Debt, not a Gift
The statement in a Promissory Note that the Obligor acknowledges and agrees that this money is really a loan, not a gift, is a very important part of a Note. Wouldn’t that be a hoot – if you could say thank you to your lender for the money you just used to buy a house???? Hah, hah. Somewhere in the Note are words that say you promise to repay this money because you know that it was just a loan. Sorry . . . nice try.
The other big part of a Note is the dollar amount – how much was borrowed. So, after agreeing to repay the loan, the rest of the Note is filled with how you are going to repay it. Take a look at the terms in the Note on the following pages, and see if you can find:
what the term of the Note is (meaning, how long do you have before all of the money is due)
what the interest rate is (‘interest’ is what the lender charges you for using its money – the cost to borrow money)
if the interest rate might change during the term of the note
if there is a prepayment penalty for paying the total amount due before the last date
if you are supposed to pay monthly, quarterly, or on some other schedule
if there is a late charge if you don’t make your payment by a certain date.
There is another term used to describe the Payee that term is called the “Note Holder.”
The Note Holder means the person who is entitled to receive the loan payments, just like the Payee or Lender. But it also means any lender who enters the picture at any time, not just the first lender.
I have Excerpted from FLORIDA FIXED RATE NOTE–Single Family–Fannie Mae/Freddie Mac UNIFORM INSTRUMENT Form 3210 1/01 to illustrate what I am saying.
Mailing Address: _____________________________________________
Mailing Address: _____________________________________________
1. BORROWER’S PROMISE TO PAY
a. In return for a loan that I have received, I promise to pay U.S. $100,000 (this amount is called “Principal”), plus Interest, to the order of the Lender.
b. I will make all payments under this Note in the form of cash, check, or money order.
c. I understand that the Lender may transfer this Note. The Lender or anyone who takes this Note by transfer and who is entitled to receive payments under this Note is called the “Note Holder.”
a. Interest will be charged on unpaid Principal until the full amount of Principal has been paid.
b. I will pay Interest at a yearly rate of 6.5%.
c. The interest rate required by this Section 2 is the rate I will pay both before and after any default described in Section 6(B) of this Note.
a. I will pay Principal and Interest by making a payment every month.
b. I will make my monthly payment on the fifth (5th) day of each month beginning on July 5, 2005.
c. I will make these payments every month until I have paid all of the Principal and Interest and any other charges described below that I may owe under this Note.
d. Each monthly payment will be applied as of its scheduled due date and will be applied to Interest before Principal.
e. If, on June 30, 2025, I still owe amounts under this Note, I will pay those amounts in full on that date, which is called the “Maturity Date.”
f. I will make my monthly payments at ______________________________ or at a different place if required by the Note Holder.
g. My monthly payment will be in the amount of U.S.$746.00.
4. BORROWER’S RIGHT TO PREPAY
I have the right to make payments of Principal at any time before they are due, known as a “Prepayment.” When I make a Prepayment, I will tell the Note Holder in writing that I am doing so. I may make a full Prepayment or partial Prepayments without paying a Prepayment charge. The Note Holder will use my Prepayments to reduce the amount of Principal that I owe under this Note. However, the Note Holder may apply my Prepayment to the accrued and unpaid Interest on the Prepayment amount, before applying my Prepayment to reduce the Principal amount of the Note. If I make a partial Prepayment, there will be no changes in the due date or in the amount of my monthly payment unless the Note Holder agrees in writing to those changes.
5. LOAN CHARGES
If a law, which applies to this loan and which sets maximum loan charges, is finally interpreted so that the interest or other loan charges collected or to be collected in connection with this loan exceed the permitted limits, then: (a) any such loan charge shall be reduced by the amount necessary to reduce the charge to the permitted limit; and (b) any sums already collected from me which exceeded permitted limits will be refunded to me.
6. BORROWER’S FAILURE TO PAY AS REQUIRED
a. Late Charge for Overdue Payments
If the Note Holder has not received the full amount of any monthly payment by the end of 10 calendar days after the date it is due, I will pay a Late Charge to the Note Holder. The amount of the Late Charge will be 1% of my overdue payment of Principal and Interest. I will pay this Late Charge promptly but only once on each late payment.
If I do not pay the full amount of each monthly payment on the date it is due, I will be in Default.
c. Notice of Default
If I am in default, the Note Holder may send me a written notice telling me that if I do not pay the overdue amount by a certain date, the Note Holder may require me to pay immediately the full amount of Principal which has not been paid and all of the Interest that I owe on that amount. That date must be at least 30 days after the date on which the notice is mailed to me or delivered by other means.
d. No Waiver By Note Holder
Even if, at a time when I am in default, the Note Holder does not require me to pay immediately in full as described above, the Note Holder will still have the right to do so if I am in default at a later time.
e. Payment of Note Holder’s Costs and Expenses
If the Note Holder has required me to pay immediately in full as described above, the Note Holder will have the right to be paid back by me for all of its costs and expenses in enforcing this Note to the extent not
prohibited by applicable law.
7. GIVING OF NOTICES
Unless applicable law requires a different method, any notice that must be given to me under this Note will be given by delivering it or by mailing it by first class mail to me at the Mailing Address above or at a different address if I give the Note Holder a notice of my different address.
Any notice that must be given to the Note Holder under this Note will be given by delivering it or by mailing it by first class mail to the Note Holder at the address stated in Section 3 above or at a different address if I am given a notice of that different address.
8. OBLIGATIONS OF PERSONS UNDER THIS NOTE
If more than one person signs this Note, each person is fully and personally obligated to keep all of the promises made in this Note, including the promise to pay the full amount owed. Any person who is a guarantor, surety or endorser of this Note is also obligated to do these things. Any person who takes over these obligations, including the obligations of a guarantor, surety or endorser of this Note, is also obligated to keep all of the promises made in this Note. The Note Holder may enforce its rights under this Note against each person individually or against all of us together. This means that any one of us may be required to pay all of the amounts owed under this Note.
9. UNIFORM SECURED NOTE
This Note is a uniform instrument with limited variations in some jurisdictions. In addition to the protections given to the Note Holder under this Note, a Mortgage, Deed of Trust, or Security Deed (the “Security Instrument”), dated the same date as this Note, protects the Note Holder from possible losses which might result if I do not keep the promises which I make in this Note. That Security Instrument describes how and under what conditions I may be required to make immediate payment in full of all amounts I owe under this Note.
WITNESS THE HAND(S) AND SEAL(S) OF THE UNDERSIGNED
In Paragraph 9 of the Note, the “Security Instrument” is mentioned. You will see that many of the terms in the Note also appear in the security document that goes along with the Note. And, a typical Loan Commitment Letter (see Appendix) usually contains most of these terms, too, just to be sure all parties understand what is required before signing.
But the Note is the core legal document – the paper that matters when proving there is a debt.
Leave a Reply
Your email address will not be published. Required fields are marked*