Key Factors in Structuring Promissory Notes

by : Nate Hananger

When the seller of a piece of property is considering carrying back a promissory note, there are certain steps they should take to structure it properly. Since an individual is incapable of altering the current economic environment which influences the rate of return an investor may pursue, it's only logical to make the particular investment they have to offer more attractive to buyers. The following aspects of a note are vital in order to acquire the highest offer possible when selling it on the secondary market. Please note, the terms "borrower" and "payor" are used interchangeably throughout this article because they both refer to the same person, the one making the payments on the note.


There amount of a down payment reflects on a borrower's financial stability. The higher the loan-to-value (LTV), the more risk there is to the investor who is considering purchasing your note.

A useful rule of thumb is to shoot for a down payment of 10% of the purchase price for a 1st position note on a single family residence (SFR). Try to obtain 20-30% for commercial property, mobile homes and land. Also try to get at least 30% down if the note is subordinate to others (was filed after other liens/notes on the property).


A person's FICO (credit score) shows how reliable they are when it comes to paying off debt. Note investors know this and pay close attention when reviewing potentially attractive notes to add to their portfolios.

Avoid buyers who object to having their credit pulled prior to selling to them. Don't just take their word, do a credit check and make sure they pay for it. Anyone with a foreclosure or bankruptcy on their record will cost you when the time comes to sell the note.

Credit scores of 650 and higher are good. The lower the credit, the steeper the discount you will face.

It's extremely beneficial to ensure accuracy when reviewing credit scores of potential buyers. Most investors make offers subject to credit checks, so their preliminary bids can change if the payor's credit score proves to be different from what was originally stated.


Real estate is the best security one can use when structuring a note. Usually the property that was sold in order to create the note in the first place is used, but cross collateralization (using separate property as extra collateral) is certainly possible too. Be certain to evaluate the condition and location of each property used as security to make sure it and its surrounding area are attractive and beneficial to the estimated value.

Avoid using property for collateral which has other underlying liens on it. This decreases the equity which either increases the discount on your note or scares buyers off completely, depending on the amount of unpaid debt.

Also make sure you know the value of the property you sell, as well as any addition property used for collateral. This doesn't mean you need to have appraisals done on each one. Everyone has a friend who is a real estate agent or knows one who can review the local market where the property is located and tell you what other comparable properties (CMA's) are being sold for in five minutes.

If you are structuring a business note, the value will be much greater if the property where the business is located is part of the collateral as well. This obviously means that companies which lease property often face bigger discounts, unless other real estate is used as security.


This means you need to use an interest rate equal to or slightly better than those which lenders and banks are offering. If interest rates are averaging at 7 percent and your note rate is 3 percent, then chances are fewer buyers will give you an offer, and those that do will increase their discount from the unpaid balance.

Many states have Usury Laws which limit personal, consumer loans. It would be wise to research your state a little before agreeing upon an interest rate. You don't want to violate state laws by exceeding the interest rate limits.

Calling a few local lenders and asking them what current rates are, as well as whether or not your state has Usury Laws, will give you all of the information you need to choose an adequate on for your note.


A note with a 15-year term is more valuable than one with a 30-year term. Why would anyone want to wait that long to get paid? Keep the term of the note as short as you can, 3-5 years is usually ideal for most note buyers. The longer-term notes are discounted much more to account for the longer waiting period to realize the return.

If you find yourself tempted to structure a note with an amortization period longer than five years because a buyer wants the monthly payments to be within reason, then give the note a longer term. However, be sure you include a 3-5 year balloon payment so the note is still paid off in a timely manner.

Notes that are too short appear as well, but not nearly as often. When this was written, I was dealing with a client whose payor had requested several extensions on the note. So if you are considering a 6-12 month term, make sure your payor can afford it.


If there's anything you can do to put your note in 1st position, then do it. This means your note will be filed before any other lien against the property and you will have first priority in the event the property is foreclosed on. If you cannot do this, then your best bet is to increase your minimum standards when it comes to the down payment and credit score from the buyer of your property.

At least 30 percent down and a FICO of 700 or better will certainly lesson your chances of taking as big of a hit when selling the note.

Subordinate notes just have higher risk, which decreases the value of the notes of the secondary market. This is why 1st position notes sell like hotcakes, 2nd position notes much less, and notes that subordinate to them (3rd, 4th, etc) are ignored by the majority of those in the cash flow industry.


Make sure the title to the property is clean. Unpaid liens will cause problems in acquiring title insurance. If that occurs, you, as the note holder, will likely face bigger problems when trying to sell the note. As a result, the investor probably won't be willing to pay for much of the closing costs, if any, leaving you with that burden. Save yourself the hassle and clear up the clouds ahead of time.


When pertaining to houses, condos and mobile homes, it usually helps the value of the note if the property is owner occupied. From an investor's standpoint, there is less risk involved if the payor is living at the same address as the property they hold a lien against.


Property that has hazardous waste on it, whether contained or not, presents a liability to the investor. Gas stations are a perfect example. This is another detail that can decrease or cancel an offer.


This may seem like a no-brainer, but I have had clients attempt to bring me notes and deeds of trust which haven't even been typed up yet. That's like selling a car which hasn't even left the factory.

Make sure you sign & date the note, have it notarized and then record it in public records. Keep it on file since you will need it to show the investor.

Furthermore, if you are selling to an LLC or Corporation, then be sure to have the buyers sign the instrument individually. If the sign as a corporate officers, then that doesn't bind them individually and you probably won't attract any serious note buyers.


Sometimes lenders prevent property owners from creating notes by using No Carryback clauses in the terms of their loans. This is something to watch out for and resolve in advance if you wish to create a note and sell it.