Never Use Promissory Notes to Acquire Real Estate Financing

Qualifying for financing is one of the biggest steps in a real estate buying process. Financing gives you confidence to broker deals and acquire properties that, through successive acquisitions, effectively build your real estate empire.

How can you secure financing to acquire real estate?

Most real estate investors will acquire what’s known as a secured form of financing. Secured financing describes a legally binding agreement between a lender and a borrower. There are two options to acquire a secured form of financing.

1.- Bank or credit union financing

The first option is to undergo the qualifying process with major financial institutions. In Canada, you can negotiate with one of Canada’s five major banks, or contact a designated mortgage lender with the appropriate credentials to lend capital for real estate acquisitions.

2.- Private equity financing

The second option is through private lending with fellow investors. One of the secrets of successful real estate investing is the acronym OPM, which stands for other people’s money. If you can acquire secured financing from a network of fellow investors, you can more easily acquire a large multifamily or commercial property. Use these multifamily assets to create a steady stream of passive income to pay back your loan and build generational wealth.

Unsecure forms of financing

However, some investors who are new to the real estate investment industry may consider unsecured sources of financing. Promissory notes are an alternative method to qualify for financing, but they’re not recommended by most experienced investors.

In fact, as an editor’s note, WealthGenius strongly advises that no one in our community use promissory notes to acquire financing.

What are promissory notes?

A promissory note, or Pnote, is an unsecured form of financing acquired from a source other than a reputable financial institution. A Pnote is a written guarantee to repay a fixed amount of money in exchange for the qualified financing. The investor signs the Pnote as part of the guarantee to repay the financing.

How are promissory notes less secure than bank loans?

Pnotes are examples of unsecured loans and are defined as when a lender agrees to provide capital without any legal claim to the borrower’s assets.

These are very different terms compared to a secured loan with a credible financial institution. Secured financing agreements give the financial institutions legal authority to take possession of a borrower’s assets in the event of a default on the loan.

Without leverage against a borrower’s assets, lenders assume much higher risk when providing unsecured loans like Pnotes. As a result, interest rates on promissory notes are often much higher compared to secured forms of financing.

Translation: expect to pay much higher monthly mortgage payments on unsecured loans like Pnotes than through loans acquired using secured financing.

What are some examples of promissory notes?

Most Pnotes contain terms and conditions that closely resemble the language used within a secured financial agreement. This includes things like:

• The total amount issued by the lender to the borrower
• A date of issuance that outlines the repayment time frame
• The maturity date stating when the Pnote balance must be repaid
• Agreed-upon repayment schedules describing the terms of repayment
• Interest rates and other lending fees charged to issue the loan
• Signatures of both the borrower and the lender to formalize the Pnote agreement

For real estate investors, there are three types of Pnote loans that can be used to secure financing for real estate investments. However, to reiterate, WealthGenius encourages our entire community to avoid using these types of loans to complete real estate deals.

- Commercial Pnotes

Though it’s more common to acquire secured mortgage loans from banks, mortgage brokers, and credit unions, it is possible to acquire a Pnote from one of these financial institutions. You can acquire a commercial Pnote from one of these institutions and use the financing as you see fit to complete your investment transaction.

- Real Estate Pnotes

These Pnotes are agreements that are entered into for the specific purpose of acquiring a mortgage to purchase a property. They can be issued by financial institutions, but it’s just as likely to be a private agreement between one individual to another.

- Informal Pnotes

The most informal of all Pnote agreements is one agreed between friends or family to help an investor finance a real estate transaction. Due to the informality of these types of Pnotes, informal agreements between close parties may not include things like repayment terms or maturity dates.

What are the risks of taking on promissory notes?

To reiterate, WealthGenius encourages our entire real estate investment community to avoid Pnotes when negotiating financing for real estate transactions. It’s more secure and, therefore, more assuring for your own state of mind to acquire secure financing with ironed out terms and conditions for both sides engaging in the transaction.

Pnotes carry additional risk that make them less than ideal for all parties. Here’s a quick overview of how those risks handicap everyone involved in a Pnote financing transaction.

- Risks to the borrower when acquiring a Pnote loan

The biggest disadvantage to a Pnote borrower is the higher interest rate costs. As an unsecured form of financing, Pnotes carry much higher risk to the lender. Those risks are passed onto the borrower in the form of higher interest rates. Higher interest rates mean more expensive monthly mortgage payments to pay off the property you acquire as an investor.

The other risk is a legal matter. In the event of a default on a Pnote, the lender has no other option but to take the borrower to court to reacquire the financing. It means more time and money will be spent trying to settle the terms of the Pnote. It’s simply not worth the risk and the consequences of acquiring a Pnote loan.

- Risks to the lender when agreeing to issue a Pnote loan

Informal Pnotes can be issued by friends, family, or close colleagues who have formed an enduring trusting relationship. Should your loved one fail to repay the outstanding balance, your only option to recoup your money is to take your loved one to court. Not only must you first obtain a judgment from the court, but you also need the means to enforce that judgment. If your loved one has no viable assets for collateral, the judgment may become meaningless.

Additionally, selling the terms of a Pnote to another investor is not as easy as selling a more secure form of financing. Other investors want the rights and security to guarantee a recuperation of any outstanding balances. Simply put, Pnotes are not worth the risk, expense, and headache that they cause.

Learn effective real estate financing from investment gurus

WealthGenius reiterates that it does not endorse or recommend Pnote financing for any real estate investor. However, there are tips and tricks that our community of experienced investment geniuses can supply to help you expand your own burgeoning real estate empire.

Join our growing real estate investment community and get the inside scoop on how to make real estate investment deals that will lay the foundation for generational wealth in the future.