A promissory note is an unsecured loan to a borrower that is based on a promise to return the money. The borrower signs a document outlining the loan terms, including length, fees, and interest, and often provides a personal guarantee, but it is not protected the same way a registered private mortgage is.
Investors may use a promissory note to supplement a shortage in funding for a construction or renovation project, or to consolidate debts when there is no room to obtain a secured mortgage. It is typically sourced in smaller chunks and used for a short-term period.
These loans typically carry double-digit interest rates of 17 percent or more because they are unsecured and represent higher risk for the lender. The lender fees are also typically more expensive than those for secured financing.
If a borrower defaults, the promissory note holder is often last in line to get paid after first, second, and third mortgages. Even if the note is registered as a caution against the property, the lender may have to pursue legal action through the court system to recoup their capital.
Over-leverage means taking on more debt than you can handle. Because promissory notes are unsecured against a property, investors can easily accumulate too much of this debt, which can cause significant problems down the road.
