A straight note requires the entire principal, together with accumulated interest to be paid in a lump sum payment at the end of the term. These notes are mostly used for short-term loans and have higher interest rates. Straight notes are usually used for small construction loans in real estate.
If you want to become a real estate agent, you must understand the types of notes and how they work. As a real estate teacher, I’ve noticed that most students don’t focus on the types of notes used in real estate despite their importance.
In this post, I will define a straight note with the help of examples. After reading this post, you can understand what a straight note is and how it works. Let’s dive in!
What Is a Straight Note?
A straight note is a note that requires interest-only payments during the mortgage term and a principal payment in the form of a balloon payment at the end. This type of note is not amortized.
On a straight note, there are no periodic payments, and the entire principal is due only at the end of the term. In real estate, these notes are used for short construction projects, up to 6 months, but can be used for mortgages of 5 to 10 years too. The monthly payments on this note include interest only and no principal. These notes have higher interest rates because of short-term.
A straight note is relatively simple. It is often referred to as a ‘bridge loan‘ in real estate, a short-term obligation. The main thing that differentiates a straight note from other notes is the amount due at maturity.
For straight notes, the amount due at maturity includes the entire principal because it hasn’t been paid earlier. With other types of notes, there are periodic payments, including interest and payment; thus, there is no amount due at the end.
Straight Note vs. Installment Note vs. Interest-Only
Installment notes are promissory notes where the monthly payments include principal and interest throughout the term. On the other hand, a straight note is also known as interest-only as it includes monthly interest payments only. On a straight note, the entire principal is due at once as a lump sum.
An installment note is used for an amortized loan, in which each payment goes toward the principal and interest. With each payment, the principal balance reduces till the end of the term until the entire mortgage is paid off. The borrower pays less interest on an installment note than on a straight note.
|Interest-only payments with principal due at the end
|Long-term and short-term mortgages
|Only short-term mortgages
|Lower rates than straight note
|Higher interest rates
Advantages of a Straight Note
- Smaller monthly payments because they include interest-only. Thus, it is suitable for those who can’t afford large monthly payments.
- Short-term mortgages help build credit quickly. The borrower can make timely monthly payments, and the lender reports it to the major credit bureaus. This allows the borrower to build a good credit score.
Disadvantages of a Straight Note
- Mortgages with a straight note have higher interest rates. This means that the mortgage is more expensive.
- A lump sum payment at the end of the term can be difficult.
- The borrower doesn’t build home equity during the term, as no payment goes toward the principal.
Straight Note Example
John purchased a small property. He applied for a short-term mortgage of $50,000 at a bank. The bank approved the mortgage at an interest rate of 5% for five years. The following is the table that shows the payment breakdown for five years:
- Mortgage amount: $50,000
- Interest rate: 5%
- Term: 5 years
As you can see in the above table, John has to make monthly payments of $2,499.96. The interest rate is high because of the short mortgage term. During the term, John doesn’t make any payment towards the principal, and at the end of the term, in year 5, he has to make a balloon payment of $50,000 along with an accumulated interest of $12,499.80. Along with interest, the cost of the mortgage is $62,499.80.
Frequently Asked Questions
What Is a Straight Promissory Note?
A straight note is a type of promissory note. It requires interest-only payments during the term of the note. At the end of the term, the note requires a lump sum payment of the principal. The borrower repays the entire principal in the form of a balloon payment.
How Long Is a Straight Note?
A straight note is short-term, around 6 months. But it can go up to 5 or 10 years too. For straight notes, the interest rate is higher because of the short-term.
What Does Balloon Payment Mean?
A straight note includes a balloon payment at the end of the loan term. A balloon payment is a lump sum payment due at the end of the mortgage term. If a person has a straight note, the monthly payments will be lower throughout the term. However, the borrower has to pay a larger amount (principal amount) at the end of the term, which is known as balloon payment.
What Is an Installment Note in Real Estate?
An installment note is a promissory note that requires periodic payments during the mortgage term. These payments include interest and principal, which the borrower pays at regular intervals. This process of periodic payment amortizes the mortgage and reduces the mortgage principal.
What to Know for the Real Estate Exam
A straight note is a type of note in which the borrower pays the only interest during the term. At the end of the term, the borrower pays a lump sum payment of the principal, which is due at the end. Since the borrower has made only interest payments and not principal payments, the principal should be paid at the time of maturity.
Since the monthly payments include interest payments only, these notes are also known as interest-only. The most common use of a straight note in real estate is for short-term debt by carryback sellers or lenders. I hope you now know the definition of a straight note and how it differs from other types of notes. If you want to learn more about such terms, go through these real estate definitions.