Over at Noteworthy.com Jon Richards and Clint Hinman really work with me in educating Real Estate Investors about Notes, Mortgage Paper, Liens and an assortment of financing instruments that make real estate investors money or gets them into a deal.
Whenever any person, partnership, trust, corporation or any other entity becomes a lender on a piece of real property, a promissory note is created. You became a lender when you sold your real estate and carried back a note.
5 Basics Terms of Seller Carry Back Notes
The Promissory Note
A promissory note is a written promise to pay a certain amount of money, and its payment is secured by some type of security instrument that becomes a lien on the real property. The note 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 person who makes the payments to you (the buyer of your property—the borrower) and the person who
receives the payments (you).
The Security Instrument
The security instrument is the document that provides for the alternate repayment of the debt to you in the case of default by the borrower. The security instrument is recorded in the county recorder’s office as a lien against the title of the property you sold.
There are three kinds of instruments used to make real estate security for a debt: (1) mortgage, with or without the power of sale; (2) deed of trust; and (3) land contract. In California, deeds of trust are by far the most common. People often call them mortgages. They account for well over 99% of the security devices used for real estate.
The land contract—known by many names such as installment contract, contract for deed, contract of sale, conditional sales contract, and the like—is used on occasion. A true mortgage is extremely rare in California. However, a discussion of mortgages helps with the understanding of other security device.
The mortgage gives the lender a lien on the real estate and hypothecates it as security for the note. The borrower, who is the buyer of the property, is called the mortgagor. The lender is called the mortgagee.
If the borrower does not pay, the lender may go to court through a procedure called a judicial foreclosure, that is, foreclosure through the courts. In this procedure, he has the court sell the property and, out of the money obtained from the sale, take enough to pay the expenses of the foreclosure and pay off the debt.
Deed of Trust
When a deed of trust is used, an additional party called a trustee is brought into the transaction. The borrower, called the trustor, transfers “bare legal title” but nothing more to the trustee. The trustee holds this title for the benefit of the lender, who is called the beneficiary.
If the borrower does not pay, the lender directs the trustee to start a foreclosure. This non-judicial foreclosure involves the process of selling the Property to a third-party bidder or, in the absence of a sufficient third-party bid, the beneficiary acquires title to the Property. The foreclosure sale, in most cases, satisfies the debt.
If you need to direct the trustee to start a non-judicial foreclosure, you may or may not be able to recover the entire loan balance. For example, if a third party bids at a non-judicial foreclosure sale an amount equal to or greater than the amount which you are owed (including fees, costs, and expenses of the foreclosure) you would be fully paid.
On the other hand, if you bid the full amount that is owed to you, including all foreclosure fees, costs, and expenses (full credit bid) and there are no third-party bids, you will generally be limited to the Property and its value as the source of repayment of the outstanding balance of the note.
A land contract comes about in a situation similar to the purchase money deed of trust. Instead of giving a deed and taking back a promissory note secured by a deed of trust, the seller enters into a land contract with the buyer in which the buyer promises to pay for the land.
Ordinarily the buyer promises to pay in installments over a period of time. In the same contract, the seller promises to deed the property to the buyer when the purchase price is fully paid.