What is an interest only promissory note?

An interest-only mortgage is a type of mortgage in which the mortgagor (the borrower) is required to pay only the interest on the loan for a certain period. The principal is repaid either in a lump sum at a specified date, or in subsequent payments.

• An interest-only mortgage is one where you solely make interest payments for the first several years of the loan, as opposed to your payments including both principal and interest.
• Interest-only payments may be made for a specified time period, may be given as an option, or may last throughout the duration of the loan (mandating you pay it all back at the end).
• Usually, interest-only loans are structured as a particular type of adjustable-rate mortgage.
• While interest-only mortgages mean lower payments for a while, they also mean you aren't building up equity, and mean a big jump in payments when the interest-only period ends.

Interest-only mortgages can be structured in various ways. Interest-only payments may be made for a specified time period, may be given as an option, or may last throughout the duration of the loan. With some lenders, paying the interest exclusively may be a provision that is only available for certain borrowers.

Most interest-only mortgages require only the interest payments for a specified time period—typically five, seven, or 10 years. After that, the loan converts to a standard schedule—a fully-amortized basis, in lender lingo—and the borrower’s payments will increase to include both interest and a portion of the principal.

Usually, interest-only loans are structured as a particular type of adjustable-rate mortgage (ARM), known as an interest-only ARM. You pay just the interest, at a fixed rate, for a certain number of years, known as the introductory period. After the introductory period ends, the borrower starts repaying both principal and interest, and the interest rate will start to vary. For example, if you take out a "7/1 ARM", it means your introductory period of interest-only payments lasts seven years, and then your interest rate will adjust once a year.

Fixed-rate interest-only mortgages are not very common; they usually exist on longer, 30-year mortgages.

At the end of the interest-only mortgage term, the borrower has a few options. Some borrowers may choose to refinance their loan after the interest-only term has expired, which can provide for new terms and potentially lower interest payments with the principal. Other borrowers may choose to sell the home they mortgaged to pay off the loan. Still, other borrowers may opt to make a one-time lump sum payment when the loan is due—having saved up by not paying the principal all those years.

Some interest-only mortgages may include special provisions that allow for just paying interest under certain circumstances. For example, a borrower may be able to pay only the interest portion on their loan if damage occurs to the home, and they are required to make a high maintenance payment. In some cases, the borrower may have to pay only interest for the entire term of the loan, which requires them to manage accordingly for a one-time lump sum payment.

Interest-only mortgages reduce the required monthly payment for a mortgage borrower by excluding the principal portion from a payment. Homebuyers have the advantage of increased cash flow and greater support for managing monthly expenses. For first-time home buyers, an interest-only mortgage also allows them to defer large payments into future years when they expect their income to be higher.

However, just paying interest also means that the homeowner is not building up any equity in the property—only the repayment of principal debt does that. Also, when payments start to include principal, they get significantly higher. This could be a problem if it coincides with a downturn in one's finances—loss of a job, an unexpected medical emergency, etc.

Borrowers should cautiously estimate their expected future cash flow to ensure that they can meet the bigger monthly obligations, and pay off the loan when required. While interest-only mortgage loans can be convenient for several reasons, they may also add to default risk.

A promissory note is a debt instrument that contains a written promise by one party (the note's issuer or maker) to pay another party (the note's payee) a definite sum of money, either on-demand or at a specified future date. A promissory note typically contains all the terms pertaining to the indebtedness, such as the principal amount, interest rate, maturity date, date and place of issuance, and issuer's signature.

Although financial institutions may issue them—for instance, you might be required to sign a promissory note in order to take out a small personal loan—promissory notes usually allow companies and individuals to get financing from a source other than a bank. This source can be an individual or a company willing to carry the note (and provide the financing) under the agreed-upon terms. In effect, promissory notes can enable anyone to be a lender.

• A promissory note is a financial instrument that contains a written promise by one party (the note's issuer or maker) to pay another party (the note's payee) a definite sum of money, either on demand or at a specified future date.
• A promissory note typically contains all the terms pertaining to the indebtedness, such as the principal amount, interest rate, maturity date, date and place of issuance, and issuer's signature.
• In terms of their legal enforceability, promissory notes lie somewhere between the informality of an IOU and the rigidity of a loan contract.

Promissory notes, as well as bills of exchange, are governed by the 1930 Geneva Convention of Uniform Law on Bills of Exchange and Promissory Notes. Its rules also stipulate that the term "promissory note" should be inserted in the body of the instrument and should contain an unconditional promise to pay.

In terms of their legal enforceability, promissory notes lie somewhere between the informality of an IOU and the rigidity of a loan contract. A promissory note includes a specific promise to pay, and the steps required to do so (like the repayment schedule), while an IOU merely acknowledges that a debt exists, and the amount one party owes another.

A loan contract, on the other hand, usually states the lender's right to recourse—such as foreclosure—in the event of default by the borrower; such provisions are generally absent in a promissory note. While the paper might make note of the consequences of non-payment or untimely payments (such as late fees), it does not usually explain methods of recourse if the issuer does not pay on time.

Promissory notes that are unconditional and saleable become negotiable instruments that are extensively used in business transactions in numerous countries.

Many people sign their first promissory notes as part of the process of getting a student loan. Private lenders typically require students to sign promissory notes for each separate loan that they take out. Some schools, however, allow federal student loan borrowers to sign a one-time, master promissory note. After that, the student borrower can receive multiple federal student loans as long as the school certifies the student's continued eligibility.

Student loan promissory notes outline the rights and responsibilities of student borrowers as well as the conditions and terms of the loan. By signing a master promissory note for federal student loans, for instance, the student promises to repay the loan amounts plus interest and fees to the U.S. Department of Education.

The master promissory note also includes the student's personal contact and employment information as well as the names and contact info for the student's personal references.

Promissory notes have had an interesting history. At times, they have circulated as a form of alternate currency, free of government control. In some places, the official currency is in fact a form of promissory note called a demand note (one with no stated maturity date or fixed-term, allowing the lender to decide when to demand payment).

In the United States, however, promissory notes are usually issued only to corporate clients and sophisticated investors. Recently, however, promissory notes have also been also seeing increasing use when it comes to selling homes and securing mortgages.

A promissory note is usually held by the party owed money; once the debt has been fully discharged, it must be canceled by the payee and returned to the issuer.

A promissory note should include all the details about a loan and the terms of repayment. In addition to the names of the borrower and the lender, it may also include:

• The total amount of money being borrowed
• The number of payments
• The monthly payment amount
• The interest rate
• Collateral requirements
• Penalties for nonpayment or default
• Conditions under which the loan may be discharged or deferred

There are several different ways to structure the repayment of a promissory note. Perhaps the most familiar term for repayment is in installments, with the borrower making regular payments against the principal and interest on the loan.

For smaller loans, it may be more practical to arrange a lump-sum repayment. Under this circumstance, the buyer has to repay all of the interest and principal at once at a predetermined date in the future. In some cases, a promissory note may specify "on demand" repayment, meaning that the note must be repaid at the lender's request. This is more common for informal loans, as between family members.

Finally, it is also possible for a promissory note to include balloon payments: the borrower makes small payments over the course of a loan, followed by one large payment to repay the remaining balance.

Homeowners usually think of their mortgage as an obligation to repay the money they borrowed to buy their residence. But actually, it's a promissory note they also sign, as part of the financing process, that represents that promise to pay back the loan, along with the repayment terms.

The promissory note stipulates the size of the debt, its interest rate, and late fees. In this case, the lender holds the promissory note until the mortgage loan is paid off. Unlike the deed of trust or mortgage itself, the promissory note is not entered into county land records.

The promissory note can also be a way in which people who don't qualify for a mortgage can purchase a home. The mechanics of the deal, commonly called a take-back mortgage, are quite simple: The seller continues to hold the mortgage (taking it back) on the residence, and the buyer signs a promissory note saying that they will pay the price of the house plus an agreed-upon interest rate in regular installments. The payments from the promissory note often result in positive monthly cash flow for the seller.

Usually, the buyer will make a large down payment to bolster the seller's confidence in the buyer's ability to make future payments. Although it varies by situation and state, the deed of the house is often used as a form of collateral, and it reverts back to the seller if the buyer can't make the payments. There are cases in which a third party acts as the creditor in a take-back mortgage instead of the seller, but this can make matters more complex and prone to legal problems in the case of default.

From the perspective of the homeowner who wants to sell, the composition of the promissory note is quite important. It is better, from a tax perspective, to get a higher sales price for your home and charge the buyer a lower interest rate. This way, the capital gains will be tax-free on the sale of the home, but the interest on the note will be taxed.

Conversely, a low sales price and a high-interest rate are better for the buyer because they will be able to write off the interest and, after faithfully paying the seller for a year or so, refinance at a lower interest rate through a traditional mortgage from a bank. Ironically, now that the buyer has built up equity in the house, they probably won't have an issue getting financing from the bank to buy it.

Promissory notes are commonly used in business as a means of short-term financing. For example, when a company has sold many products but has not yet collected payments for them, it may become low on cash and unable to pay creditors. In this case, it may ask them to accept a promissory note that can be exchanged for cash at a future time after it collects its accounts receivables. Alternatively, it may ask the bank for the cash in exchange for a promissory note to be paid back in the future.

Promissory notes also offer a credit source for companies that have exhausted other options, like corporate loans or bond issues. A note issued by a company in this situation is at a higher risk of default than, say, a corporate bond. This also means the interest rate on a corporate promissory note is likely to provide a greater return than a bond from the same company—high-risk means higher potential returns.

These notes usually have to be registered with the government in the state in which they are sold and/or with the Securities and Exchange Commission (SEC). Regulators will review the note to decide whether the company is capable of meeting its promises. If the note is not registered, the investor has to do their own analysis as to whether the company is capable of servicing the debt.

In this case, the investor's legal avenues may be somewhat limited in the case of default. Companies in dire straits may hire high-commission brokers to push unregistered notes on the public.

Investing in promissory notes, even in the case of a take-back mortgage, involves risk. To help minimize these risks, an investor needs to register the note or have it notarized so that the obligation is both publicly recorded and legal.

Also, in the case of the take-back mortgage, the purchaser of the note may even go so far as to take out an insurance policy on the issuer's life. This is perfectly acceptable because if the issuer dies, the holder of the note will assume ownership of the house and related expenses that they may not be prepared to handle.

These notes are only offered to corporate or sophisticated investors who can handle the risks and have the money needed to buy the note (notes can be issued for as large a sum as the buyer is willing to carry). After an investor has agreed to the conditions of a promissory note, they can sell it (or even the individual payments from it), to yet another investor, much like a security.

Notes sell for a discount from their face value because of the effects of inflation eating into the value of future payments. Other investors can also do a partial purchase of the note, buying the rights to a certain number of payments—once again, at a discount to the true value of each payment. This allows the note holder to raise a lump sum of money quickly, rather than waiting for payments to accumulate.

By bypassing banks and traditional lenders, investors in promissory notes are taking on the risk of the banking industry without having the organizational size to minimize that risk by spreading it out over thousands of loans. This risk translates into larger returns—provided that the payee doesn't default on the note.

In the corporate world, such notes are rarely sold to the public. When they are, it is usually at the behest of a struggling company working through unscrupulous brokers who are willing to sell promissory notes that the company may not be able to honor.

In the case of take-back mortgages, promissory notes have become a valuable tool to complete sales that would otherwise be held up by a lack of financing. This can be a win-win situation for both the seller and buyer, as long as both parties fully understand what they are getting into.

If you are looking to perform a take-back mortgage purchase or sale, you should have a talk with a legal professional and visit the notary office before you sign anything.

A form of debt instrument, a promissory note represents a written promise on the part of the issuer to pay back another party. A promissory note will include the agreed-upon terms between the two parties, such as the maturity date, principal, interest, and issuer’s signature. Essentially, a promissory note allows entities aside from financial institutions the ability to provide lending mechanisms to other entities.

One example of a promissory note is a corporate credit promissory note. For this type of promissory note, a company will be typically seeking a short-term loan. In the case of a growing startup that is low on cash as it expands its operations, terms of the agreement could follow that the company pays back the loan once its accounts receivable are collected.

There are a number of other different types of promissory notes including investment promissory notes, take-back mortgages, and student loan promissory notes. 

A promissory note can be advantageous when an entity is unable to find a loan from a traditional lender, such as a bank. However, promissory notes can be much riskier because the lender does not have the means and scale of resources found within financial institutions. At the same time, legal issues could arise for both the issuer and payee in the event of default. Because of this, getting a promissory note notarized can be important.

A promissory note is a written promise by one party to make a payment of money at a date in the future. Although they may be issued by financial institutions, it is also common for other organizations or individuals to use promissory notes to confirm the agreed terms of a loan. In short, a promissory note allows anyone to act as a lender.