A promissory note investment is the purchase of a written promise to pay: you buy the right to collect the payments a borrower owes. The single most important question is whether the note is secured, meaning backed by collateral such as real estate, or unsecured, backed only by the borrower’s word. That one fact drives most of the risk and most of the price.
This post explains the types of promissory notes investors buy, how secured and unsecured notes differ when things go wrong, and how to avoid the promissory note offerings that regulators warn about.
What a promissory note is
A promissory note is a signed document in which one party (the payer or maker) promises to pay another (the payee or holder) a set sum, usually with interest, on a set schedule. It states the amount, the rate, the payment dates, what happens if a payment is late, and what counts as default. Notes can be sold and transferred, which is what makes them investable. Our page on the promissory note covers the basic terms.
The kinds of promissory notes investors buy
Real estate notes
A note secured by a mortgage or deed of trust on property. If the borrower defaults, the holder can foreclose and look to the property. These are the most widely traded private notes.
Business notes
Created when an owner sells a business and takes part of the price in payments. Some are secured by business assets, a personal guarantee or real estate. Many are secured only by the business itself, which can lose value quickly if the new owner struggles. See business notes.
Personal and unsecured notes
Loans between individuals, or to a company, with no collateral. If the borrower stops paying, the holder’s remedy is to sue and try to collect a judgment.
Secured vs unsecured, side by side
| Secured note | Unsecured note | |
|---|---|---|
| Backed by | Property or other collateral, with a recorded lien | The borrower’s promise and credit only |
| If the borrower defaults | Holder can foreclose or repossess the collateral | Holder can sue, then try to collect a judgment |
| In a bankruptcy | Generally stands ahead of unsecured creditors, up to the collateral’s value | Often paid little or nothing |
| Buyer interest | Many buyers, more competitive pricing | Few buyers, deep discounts or no offer |
More on this in secured vs unsecured notes.
A worked example
Say two people each hold a $50,000 note paying 8% interest, and both borrowers stop paying after two years. The figures are illustrative.
- Note A is secured by a recorded first mortgage on a house worth about $120,000. The holder can foreclose. After legal costs and time, there is a reasonable chance of recovering the balance from the property, because there is about $70,000 of equity above the loan.
- Note B is an unsecured note to a small company. The holder sues and wins a judgment. But if the company has closed or has little cash, the judgment may collect very little.
Before the default, the two notes looked similar: same balance, same rate, same payments. After it, they are worth very different amounts. That is why a buyer would pay much less for Note B on day one, and why many buyers will not quote an unsecured note at all.
How to judge a promissory note investment
- Read the note itself. Rate, term, late fees, default and acceleration clauses, and whether it can be transferred.
- Confirm the security. For a real estate note, check that the mortgage or deed of trust is recorded and in the lien position you expect. For other collateral, check the lien filing.
- Value the collateral with a current, independent estimate.
- Check the payer. Credit, income and payment history.
- Verify the seller. Make sure the person selling the note actually holds it and has the original. See how to verify a note seller.
- Price for the risk. The weaker the security and the payer, the higher the yield you should need, which means a lower price.
A warning about “promissory note” offerings
There is a different product that also uses the name. Some companies sell their own promissory notes to the public, promising a high fixed return, often through agents who earn commissions. Securities regulators have warned for years that many of these are unregistered securities, and some have turned out to be frauds.
Buying an existing private note secured by a specific property you can check is a different thing from lending money to a company that promises a fixed rate. Warning signs include:
- A guaranteed or unusually high return with “no risk.”
- No specific property or collateral you can verify.
- Pressure to decide quickly.
- A seller who is not registered, or an offering not registered with the SEC or your state securities regulator.
If you see these, check with your state securities regulator before you send money.
What if you hold an unsecured note and want to sell?
It is possible but harder. Fewer buyers look at unsecured notes, and the discount is steep. A strong payment history and a payer with good credit help. See can I sell an unsecured promissory note.
Bottom line
Promissory notes can be sound investments when you know what backs them and price them for that. Secured notes, especially first-lien real estate notes, have a clear path to recovery if the payer stops. Unsecured notes depend on the borrower alone. Verify the collateral, the payer and the seller, and be wary of anyone selling notes with a promised return. If you hold a secured note and want to see what it would bring, you can get it priced with the math shown.
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