Definition
A Promissory Note is a written legal promise by a borrower to repay a specific sum of money to a lender under defined terms.
It outlines the financial obligations of the borrower, including repayment schedule, interest rate, maturity date, and default provisions.
Key Components
- Principal Amount: The original loan balance.
- Interest Rate: Fixed or variable rate charged on the loan.
- Payment Schedule: Monthly, quarterly, or other agreed structure.
- Maturity Date: Date the loan must be fully repaid.
- Default Provisions: Rights and remedies if borrower fails to pay.
- Prepayment Terms: Rules governing early repayment.
Promissory Note vs. Deed of Trust
- Promissory Note: The borrower’s promise to repay.
- Deed of Trust (or Mortgage): The security instrument that uses the property as collateral.
The note creates the debt; the deed of trust secures it.
Why It Matters to Investors
- Defines repayment obligations and loan economics
- Controls interest accrual and amortization
- Determines lender remedies in default
- Affects refinance and exit flexibility
Example
An investor borrows $8 million at 6.5% interest, amortized over 30 years, with a 5-year maturity. The promissory note specifies monthly payments, late fees, and a balloon payment at maturity.
Common Pitfalls
- Ignoring prepayment penalties
- Overlooking default interest rates
- Misunderstanding recourse provisions
- Failing to review acceleration clauses