What is a “promissory note?” A promissory note is a written promise to pay or repay a certain amount of money at a certain time, or in a certain number of installments, or on demand to a named person. It usually provides for payment of interest, and its payment can be secured by a deed of trust.
The person receiving the loan proceeds (borrower) becomes obligated to repay the debt by signing a promissory note which specifies:
(1) the amount of the loan (principal);
(2) the interest rate (interest);
(3) the amount and frequency of payments (debt service);
(4) when the borrower must repay the principal (due date); and
(5) the penalties imposed if the borrower fails to timely pay or tender a payment (late charge) or decides to pay a portion or all of the principal prior to the due date (prepayment penalty). The promissory note identifies the borrower and the person who will receive the payments (lender or note holder).
Private mortgage notes (trust deeds) are loans secured by real estate made by a private lender instead of a bank, lending institution or government agency. The private mortgage notes we are concerned with here are short-term (6 months – 3 years) hard money or asset based loans. This means that the decision to lend is based on the equity and value of the property being put up as collateral, not on the borrower’s credit. The security for the loan is enhanced because the loan represents a maximum of 60% of the appraised value of the income producing property. On non-income producing property (raw land, lots, construction money) a maximum of 40% loan to value is lent. Investors can expect interest rates of 12 to 18% on 1st liens in this current low interest rate environment. Historically 1st lien yield of 6 points over prime has been obtainable.
Some private mortgage loans are made to homeowners. The types of private mortgage loans we recommend are made to professional real estate investors and commercial property owners. The advantages of lending to commercial real estate investors vs. homeowners are threefold.
First homestead laws do not apply to investor owned property; in addition state usury laws and disclosure laws are much more relaxed on non-owner occupied property. Second, income-producing property allows borrowers to pay the loan payments from the properties’ income, not out of pocket, making for a safer loan. And finally, there are a lot more opportunities to lend money at high interest rates and low loan to value ratios on commercial and investment property than there are on owner occupied single family residences.
Private mortgage note investments are ideal for both the retired investors seeking to increase his interest income and the growth investor seeking to increase the value of his portfolio. Yields in the 15% range allow the retirement income investor the chance to substantially increase his income and hence his lifestyle with little additional risk vs. bond, CD or fixed income mutual funds. The growth investor can continually reinvest his interest payments into more mortgage notes thereby building up a large portfolio of these private mortgage investments.
In the rare event of default, the private mortgage investor will begin foreclosure proceedings. Should payments, penalties and legal fees (as spelled out in the note) not be caught up to date by the borrower, the trustee will foreclose on the property serving as In the rare event of default, the private mortgage investor will begin foreclosure proceedings. Should payments, penalties and legal fees (as spelled out in the note) not be caught up to date by the borrower, the trustee will foreclose on the property serving as collateral for the promissory note. An auction will be held, and the lender (private mortgage investor) will either receive the total amount of the principal of the note (if property bid on and purchased by an outside bidder) or the trustee will bid the amount of principal, interest and penalties due and the mortgage investor will receive title to the property. Since the property will be worth significantly more than the amount owed, opportunity exists for significant additional profit. In fact many private mortgage investors look forward to obtaining ownership of income producing property at significant discounts should foreclosure become necessary.