If you get a mortgage to buy a home, you will end up signing something called a promissory note. So what exactly is a promissory note?
In the most basic terms, it’s a legal document you sign containing a written “promise” to pay a lender, says Scott A. Marcus, a shareholder in Becker & Poliakoff’s Real Estate Practice Group, in Fort Lauderdale, FL.
Promissory notes are a standard part of all real estate financing contracts and include basic information such as:
The amount due
The terms of repayment (e.g., do the payments include principal and interest, or only interest)
The interest rate and whether it can change or is fixed
Whether there is a prepayment penalty
The loan maturity date
The names of the lender and borrower
Promissory notes are an important yet often misunderstood part of the loan process.
“The worst mistake someone signing a promissory note can make is to sign a note without reading and understanding all of its terms,” says Marcus.
So let’s clear up a few common misconceptions, shall we?
Promissory note vs. a mortgage: What’s the difference?
Many home buyers mistakenly think that the mortgage—another contract they sign—is their promise to pay back the loan.
Well, they’re wrong! The promissory note is your promise to do that, plain and simple. The mortgage, on the other hand, is a contract that kicks in more when things go wrong.
In a nutshell, a mortgage (also called a deed of trust) is a pledge you sign to put up your property as collateral in case you default on your loan, according to David Reiss, professor of law at Brooklyn Law School and editor of REFinBlog.com.
In other words, if you suddenly find yourself unable to repay your home loan, your lender will eventually confiscate your property and sell it as a foreclosure to help it recoup its losses from lending you all that money.
Ben Carson, the nominee for secretary of the U.S. Department of Housing and Urban Development (HUD), has made almost no public pronouncements about housing policy. The one exception is a Washington Times opinion piece from 2015 in which he addresses an Obama administration rule on fair housing.
While Carson appears to agree with the Obama administration’s diagnosis of the problem of segregation, he attacks its solution. If he refuses to vigorously enforce the rule at HUD, it is still incumbent on him to address the underlying problem it was meant to address.
Carson acknowledges the history of structural racism in American housing markets. He notes that segregation was caused in part by the federal government’s reliance on “redlining,” which refers to the Federal Housing Administration’s mid-20th century practice of drawing a red line around minority communities on underwriting maps and then refusing to insure mortgages within those borders.
He also acknowledges that racially restrictive covenants played a significant role in maintaining segregation. Racially restrictive covenants were legally enforceable agreements among property owners to keep homes from being sold to members of various minority groups. African Americans were the group most often targeted by them.
These covenants were very common in the mid-20th century, until the Supreme Court ruled that they were not legally enforceable. Shockingly, the Federal Housing Administration continued to encourage their use, even after the Supreme Court’s ruling.
Carson also acknowledged that “the Fair Housing Act and other laws have greatly reduced explicit discrimination in housing” but that “significant disparities in housing availability and quality persist.”
All in all, Carson’s take on the history of American housing policy is consistent with the consensus view across the left and the right: the federal government promoted segregationist housing policies for a large part of the 20th century.
Where he veers sharply from the Obama administration is in crafting a solution. The Obama administration promulgated a rule pursuant to the Fair Housing Act that would require localities to affirmatively promote fair housing if they chose to take funds from HUD.
While Carson states that the Obama rule is based on a “tortured reading of Fair Housing law,” the statutory authority for it is pretty clear. The Fair Housing Act states that HUD is to administer housing programs “in a manner affirmatively to further the policies” of the law.
Carson has characterized the Obama administration rule as a “socialist experiment.” I think his characterization is just plain wrong, particularly because the federal government often ties the provision of federal funds to various policy goals.
Think, for instance, of how federal highway dollars were tied to lowering state speed limits to 55 miles an hour. Such linkages are hardly socialist experiments. They merely demonstrate the power of the purse, a long-time tool of the federal government. Even if Carson cannot be convinced of this, the debate over how to address this legacy of discrimination does not end there.
After all, Carson’s opinion identified a serious problem: segregation resulting from longstanding policies of the federal government. He then stated that he does not agree with the Obama administration’s approach to solving the problem. He concluded by stating, “There are reasonable ways to use housing policy to enhance the opportunities available to lower-income citizens.” But he failed to identify a single policy to address the problems caused by those longstanding and discriminatory federal policies.
If confirmed, Carson must outline how the U.S. Department of Housing and Urban Development can address the legacy of structural racism in American housing markets. The text of the Fair Housing Act makes it clear that HUD must administer its housing programs in a manner that would affirmatively further the policies of the law.
The problem Carson faces is clear. The duty imposed upon him by the law is clear. What remains unclear is how he will fulfill that duty. He has both a legal and moral obligation to set forth his vision, if he is bent on rejecting that of President Obama.
As home ownership rates declined in the past decade, more and more people have opted to rent homes. This provided a niche market for young professionals: luxury rental home communities.
Arizona-based NexMetro Communities has developed Avilla Homes, which COO Josh Hartmann calls a “hybrid between single-family living and apartment living,” with communities in the Phoenix and Tucson areas, as well as recent expansion into Denver and Dallas suburbs.
Hartmann said the draw of Avilla Homes is it is a unique hybrid: providing the feel of living in your own house without the responsibilities of being a homeowner. It incorporates some aspects of apartment living, such as on-call maintenance, but focuses on the draw of living in a single-family home, such as four-walled individual units with one’s own yard space.
“I think (owning a home) is less of a draw for investment’s sakes and if you take that away, owning a home is a lot of work,” Hartmann said. “You have to be constantly fixing things. What the real draw of our product is that you don’t have to worry about all those things but you still get to live in a home.”
When the project first began in Tucson in 2011, the board of directors thought its main consumer would be people who lost their homes in the recession and were looking to rent. But the project ended up being a success with an unexpected demographic-the millennials.
Hartmann attributes millennials’ attitude toward homeownership and how they spend their money as a factor in the communities’ success. He estimates that about 65 percent of Avilla Homes’ customers are early in their career, between the ages of 25 and 34.
“I just think what they want to spend the dollars they make on is different than what my generation or the generation before me did,” Hartmann said.
David Reiss, a professor of law at Brooklyn Law School says lifestyle changes coupled with the recession caused many people to turn to renting. The nation’s home ownership was down to 63.7 percent in the first quarter of 2015 from about 69 percent in 2004, according to census data.
“Another piece of it is kind of long term trends: Household formation, student loans that millennials have, another thing is income and job security,” said Reiss. ” A lot of things people have in place before they want to be a homeowner are not in many households.”
Expect a pullback in fair lending enforcement in 2017, and especially less focus on disparate impact discrimination as the Trump administration takes office.
That’s the assessment of banking attorneys and others weighing the role of the Consumer Financial Protection Bureau, the Department of Housing and Urban Development, and the Justice Department in the uncertain year ahead.
Although a recent court ruling raises questions about CFPB Director Richard Cordray’s tenure, several said they expect the CFPB to be less assertive no matter who heads the agency.
Meanwhile, new leadership at the Justice Department and HUD means that disparate impact claims—allegations of discriminatory effect, without regard to subjective intent—will get less attention than in recent years.
David Reiss, professor of law at Brooklyn Law School in Brooklyn, N.Y., summed up the assessment of several interviewed by Bloomberg BNA on the picture ahead for 2017.
“I would guess that disparate impact won’t be a priority for the Trump administration,” Reiss said.
New Leadership Ahead
In November, Trump said he’ll nominate Sen. Jeff Sessions (R-Ala.) as attorney general. The president-elect also Dec. 5 named Ben Carson, the former director of pediatric neurosurgery at Johns Hopkins, as his candidate to lead HUD.
Alan S. Kaplinsky, a partner in Philadelphia who leads the consumer financial services practice at Ballard Spahr, said he doesn’t expect Sessions “to be a strong advocate for pushing the legal envelope on fair lending issues.”
And Carson might not use what some have called an “enforcement by litigation” approach to housing policy, according to Joseph Pigg, the American Bankers Association’s senior vice president for mortgage finance.
“Returning to a more normal enforcement regime should be a positive for borrowers and lenders alike,” Pigg told Bloomberg BNA. HUD spokesman Brian Sullivan declined to comment on the fair-lending outlook at HUD.
A Well-Known Unknown
Carson, a well-known physician and education reform advocate, took on an even higher profile by entering the 2016 White House race. But on lending, housing and other matters likely to come before him should he take the helm at HUD, Carson’s record is sparse.
One exception is a July 23, 2015, opinion piece in the Washington Times, where Carson criticized HUD’s Affirmatively Furthering Fair Housing rule. Although HUD has a distinct regulation that governs disparate impact claims under the Fair Housing Act, the AFFH rule has a different focus. The regulation, drawn from language in the Fair Housing Act itself, lays out a new process that HUD says “promotes housing choice and fosters inclusive communities free from housing discrimination.”
Carson criticized the AFFH rule, saying it would inject too much government decision-making into local housing policy. The rule, issued in the wake of the U.S. Supreme Court’s ruling in a major 2015 case on disparate impact claims under the Fair Housing Act, might actually frustrate efforts to develop new housing, he said.
Reiss predicted that Carson will either try to get rid of the AFFH rule, or decide not to enforce it. But he also said Carson’s stance on the regulation probably is somewhat nuanced.
“He’s acknowledged the history of redlining, restrictive covenants, and other problems,” Reiss told Bloomberg BNA. “He doesn’t seem to be denying a history of structural racism in the housing market. He seems to be saying the Affirmatively Furthering Fair Housing rule goes too far.”
On a chilly December afternoon in Atlanta, a judge told Reiton Allen that he had seven days to leave his house or the marshals would kick his belongings to the curb. In the packed courtroom, the truck driver, his beard flecked with gray, stood up, cast his eyes downward and clutched his black baseball cap.
The 44-year-old father of two had rented a single-family house from a company called HavenBrook Homes, which is controlled by one of the world’s biggest money managers, Pacific Investment Management Co. Here in Fulton County, Georgia, such large institutional investors are up to twice as likely to file eviction notices as smaller owners, according to a new Atlanta Federal Reserve study.
“I’ve never been displaced like this,” said Allen, who said he fell behind because of unexpected childcare expenses as his rent rose above $900 a month. “I need to go home and regroup.”
Hedge funds, large investment firms and private equity companies helped the U.S. housing market recover after the crash in 2008 by turning empty foreclosures from Atlanta to Las Vegas into occupied rentals.
Now among America’s biggest landlords, some of these companies are leaving tenants like Allen in the cold. In a business long dominated by mom-and-pop landlords, large-scale investors are shifting collections conversations from front stoops to call centers and courtrooms as they try to maximize profits.
“My hope was that these private equity firms would provide a new kind of rental housing for people who couldn’t — or didn’t want to — buy during the housing recovery,” said Elora Raymond, the report’s lead author. “Instead, it seems like they’re contributing to housing instability in Atlanta, and possibly other places.”
American Homes 4 Rent, one of the nation’s largest operators, and HavenBrook filed eviction notices at a quarter of its houses, compared with an average 15 percent for all single-family home landlords, according to Ben Miller, a Georgia State University professor and co-author of the report. HavenBrook — owned by Allianz SE’s Newport Beach, California-based Pimco — and American Homes 4 Rent, based in Agoura Hills, California, declined to comment.
Colony Starwood Homes initiated proceedings on a third of its properties, the most of any large real estate firm. Tom Barrack, chairman of U.S. President-elect Donald Trump’s inauguration committee, and the company he founded, Colony Capital, are the largest shareholders of Colony Starwood, which declined to comment.
Diane Tomb, executive director of the National Rental Home Council, which represents institutional landlords, said her members offer flexible payment plans to residents who fall behind. The cost of eviction makes it “the last option,” Tomb said. The Fed examined notices, rather than completed evictions, which are rarer, she said.
“We’re in the business to house families — and no one wants to see people displaced,” Tomb said.
According to a report last year from the Harvard Joint Center for Housing Studies, a record 21.3 million renters spent more than a third of their income on housing costs in 2014, while 11.4 million spent more than half. With credit tightening, the homeownership rate has fallen close to a 51-year low.
In January 2012, then-Federal Reserve Chairman Ben Bernanke encouraged investors to use their cash to stabilize the housing market and rehabilitate the vacant single-family houses that damage neighborhoods and property values.
Now, the Atlanta Fed’s own research suggests that the eviction practices of big landlords may also be destabilizing. An eviction notice can ruin a family’s credit and make it more difficult to rent elsewhere or qualify for public assistance.
Collection Strategy?
In Atlanta, evictions are much easier on landlords. They are cheap: about $85 in court fees and another $20 to have the tenant ejected, according to Michael Lucas, a co-author of the report and deputy director of the Atlanta Volunteer Lawyers Foundation. With few of the tenant protections of places like New York, a family can find itself homeless in less than a month.
In interviews and court filings, renters and housing advocates said that some investment firms are impersonal and unresponsive, slow to make necessary repairs and quick to evict tenants who withhold rent because of complaints about maintenance. The researchers said some landlords use an eviction notice as a “routine rent-collection strategy.”
Aaron Kuney, HavenBrook’s former executive director of acquisitions, said the companies would rather keep their existing tenants as long as possible to avoid turnover costs.
But “they want to get them out quickly if they can’t pay,” said Kuney, now chief executive officer of Piedmont Asset Management, a private equity landlord in Atlanta. “Finding people these days to rent your homes is not a problem.”
Poor Neighborhoods
The Atlanta Fed research, based on 2015 court records, marks an early look at Wall Street’s role in evictions since investment firms snapped up hundreds of thousands of homes in hard-hit markets across the U.S.
Researchers found that evictions for all kinds of landlords are concentrated in poor, mostly black neighborhoods southwest of the city. But the study found that the big investors evicted at higher rates even after accounting for the demographics of the community where homes were situated.
Tomb, of the National Rental Home Council, said institutional investors at times buy large blocks of homes from other landlords and inherit tenants who can’t afford to pay rent. They also buy foreclosed homes whose occupants may refuse to sign leases or leave.
Those cases make the eviction rates appear higher than for smaller landlords, according to Tomb, whose group represents Colony Starwood, American Homes 4 Rent and Invitation Homes. The largest firms send notices at rates similar to apartment buildings, which house the majority of Atlanta renters.
Staying Home
Not all investment firms file evictions at higher rates. Invitation Homes, a unit of private equity giant Blackstone Group LP that is planning an initial public offering this year, sent notices on 14 percent of homes, about the same as smaller landlords, records show. In Fulton County, Invitation Homes works with residents to resolve 85 percent of cases, and less than 4 percent result in forced departures, according to spokeswoman Claire Parker.
The Fed research doesn’t say why many institutional investors evict at higher rates. It could be because their size enables them to negotiate less expensive legal rates and replace renters more quickly than mom-and-pop operators.
“Lots of small landlords, when they have good tenants who don’t cause trouble, they’ll work with someone who has lost a job or can’t pay for the short term,” said David Reiss, a Brooklyn Law School professor who specializes in residential real estate.
The dark, dark days of the mortgage market are far behind us. The early 2000s were marked by a set of practices that can only be described as abusive. Consumers saw teaser interest rates that morphed into unaffordable rates soon thereafter, high fees that were foisted upon borrowers at the closing table and loans packed with unnecessary and costly products like credit insurance.
After the financial crisis hit, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The law included provisions intended to protect both borrowers and lenders from the craziness of the previous decade, when no one was sufficiently focused on whether loans would be repaid or not.
The Consumer Financial Protection Bureau (CFPB) promulgated the rules that Dodd-Frank had called for, like the ability-to-repay and qualified mortgages rules. These rules achieved their desired effect as predatory mortgage loans all but disappeared from the market.
But there were consequences, and they were not wholly unexpected. Mortgage credit became tighter than necessary. People who could reliably make their mortgage payments were not able to get a mortgage in the first place. Perhaps their income was unreliable, but they had a good cushion of savings. Perhaps they had more debts than the rules thought advisable, but were otherwise frugal enough to handle a mortgage.
These people banged into the reasonable limitations of Dodd-Frank and could not get one of the plain vanilla mortgages that it promoted. But many of those borrowers found out that they could not go elsewhere because lenders avoided making mortgages that were not favored by Dodd-Frank’s rules.
Commentators were of two minds when these rules were promulgated. Some believed that an alternative market for mortgages, so-called non-qualified mortgages, would sprout up beside the plain vanilla market, for good or for ill. Others believed that lenders would avoid that alternative market like the plague, again for good or for ill. Now it looks like the second view is mostly correct and it is mostly for ill.
The Urban Institute Housing Finance Policy Center’s latest credit availability index shows that mortgage availability remains weak. The center concludes that even if underwriting loosened and current default risk doubled, it would remain manageable given past experience.
The CFPB can take steps to increase the credit box from its current size. The “functional credit box” refers to the universe of loans that are available to borrowers. The credit box can be broadened from today’s functional credit box if mortgage market players choose to thoughtfully loosen underwriting standards, or if other structural changes are made within the industry.
The CFPB in particular can take steps to encourage greater non-qualified mortgage lending without needing to amend the ability-to-repay and qualified mortgages rules. CFPB Director Richard Cordray stated earlier this year that “not a single case has been brought against a mortgage lender for making a non-[qualified mortgage] loan.”
But lenders have entered the non-qualified mortgage market very tentatively and apparently need more guidance about how the Dodd-Frank rules will be enforced. Moreover, some commentators have noted that the rules also contain ambiguities that make it difficult for lenders to chart a path to a vibrant non-qualified mortgage line of business. Lenders are being very risk-averse here, but that is pretty reasonable given that some violations of these rules can result in criminal penalties, including jail time.
The mortgage market of the early 2000s provided mortgage credit to too many people who could not make their monthly payments on the terms offered. The pendulum has now swung. Today’s market offers very few unsustainable mortgages, but it fails to provide credit to some who could afford them. That means that the credit box is not at its socially optimal size.
The CFPB should make it a priority to review the regulatory regime for non-qualified mortgages in order to ensure that the functional credit box is expanded to more closely approximate the universe of borrowers who can pay their mortgage payments month in, month out. That would be good for those individual borrowers kept out of the housing market. It would also be good for society as a whole, as the financial activity of those borrowers has a multiplier effect throughout the economy.
Buying a home can sometimes feel like learning a new language. Preapprovals, appraisals and the fact that “concessions” don’t involve hot dogs at a baseball game can be more than a little bewildering for first-time homebuyers. If you’re in the market for a mortgage, the more you know, the more confident you’ll be with each transaction during the life of the loan. If you find yourself scratching your head over mortgage lingo, we’d like to make your contract a little clearer by explaining two items that are often confused for one another: a promissory note and a mortgage.
What’s a Promissory Note?
Essentially, a promissory note is an agreement that promises that the money borrowed from a lender will be paid back by the borrower. “It also includes how the loan is to be repaid, such as the monthly amount and the length of time for repayment,” explains David Bakke, a finance expert at MoneyCrashers.com.
Although the home loan process involves both a mortgage and a promissory note, a promissory note can be used singularly in a lending relationship between two individuals. In this case, a promissory note is simply a promise to pay back the amount of money that is borrowed in a set amount of time.
“Another way to think of it is that the promissory note is the IOU for the home loan,” says David Reiss, who teaches about residential real estate as a law professor at Brooklyn Law School in New York.
What Is a Mortgage?
The second part of the home loan involves a mortgage, also referred to as a deed of trust. While a promissory note provides the financial details of the loan’s repayment, such as the interest rate and method of payment, a mortgage specifies the procedure that will be followed if the borrower doesn’t repay the loan.
“The actual home loan (or mortgage) provides information as far as the lender being able to demand complete repayment if the loan goes into default, or that the property can be sold if the buyer fails to repay,” says Bakke.
In the case of a home loan, the promissory note is a private contract between the client and the lender, while the mortgage is filed in the regional government records office. “Once you have paid off your loan your lender will record a document that releases you from the liability of the deed of trust and the promissory note,” says Ross Kilburn, CEO of Ark Law Group, PLLC.
It’s a Package Deal
In the home loan process, a mortgage and a promissory note are not a question of one or the other, but rather, both play distinct roles in the relationship between the lender and borrower. “A home loan refers to a transaction where a borrower borrows money from the lender and in turn signs a promissory note that reflects the indebtedness as well as a mortgage that gives a security interest in the home in case the debt is not paid back,” explains Reiss.
