PROMISSORY NOTE

General

Promissory Note is a binding agreement to pay the promised sum to the payee named in the Promissory Note. To make the promissory note effective one must mention the date and time when the payments are due and the interest rate. The promissory note can be made to be payable on demand or on a fixed date.

A promissory note can be enforced in a Court of Law and the judgment you obtain can be enforced against the person or persons who wrote the promissory note. The ability to collect on the money depends on the assets and income of the borrower. It is essentially a covenant to pay and does not provide the security for the payment.

Interest

Under the Canadian Law interest in the promissory note cannot exceed 60% and if it does it becomes a criminal offence and the promissory note can be struck off as an invalid document. Under the Interest Act of Canada the interest must also be a fixed percentage and not an uncertain amount. Banks usually charge interest rate depending on the prime rate of the bank of Canada.

Amortization

Repayment of the promissory note can be on account of interest only or ‘blended’ payments of interest and principal. There are computer programmes which can work out payment of a fixed monthly sum which is made up of the interest and a portion of the principal. These programmes can work out the exact amount of interest each month. In a blended payment arrangement the interest portion of the fixed amount is higher in the earlier years and allows a smaller amount of principal to be paid in the initial years but a larger amount of principal and lower amount of interest as more and more of the principal has been paid off. The calculation of the time period required to pay off the full amount of principal and interest is called amortization.

Mortgage

If the lender wants security of a lien on the assets of the borrower, one of the ways to obtain that security is by way of a mortgage on the property of the borrower. If a bank is lending money for the purchase of a house then the bank will hold a first mortgage and the private lender can have a second mortgage on the property. The security of the mortgage protects the lenders in the order of priority in which they are registered, i.e. if the borrower fails to make payment the first mortgage holder, called the mortgagee, he has the first right to sell the property and after he is paid off the balance is used for the second mortgagee or lender.

Mortgage Ratios

The banks in Canada are not permitted to lend more than 75% of the value of the property when they lend on the security of the first mortgage. The reason for this is to ensure that the borrower has a stake in the equity of the property by way of putting his own money in his own property. Therefore it is very often a condition of the lending of the first mortgage funds that the borrower puts in 25% of his own money as down payment for the purchase of a residential property. If the borrower does not have 25% of the value of the house as down payment he needs a high ratio mortgage which then requires insurance from the Central House and Mortgage Corporation which guarantees the bank the payment if the borrower fails to pay.

Lending by a Relative

If a relative is lending money the relative must consider the relationship with the borrower and decide if there is a need for a mortgage or not. A mortgage provides tangible security but impairs the ability in some cases of the borrower to borrow from the regular mortgage lender like a bank.