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Negotiable Instrument


Document that indicates a borrower’s debt. Additionally, the negotiable instrument is used as security for the lender to guarantee the borrower will pay back a debt on a specified date or within a certain amount of days, weeks, or years.


A negotiable instrument is a legal note that ensures the debt owed by a borrower to a lender is guaranteed by having the terms of the agreement in writing. Negotiable instruments can be banknotes, bills of exchanges, or promissory notes.

The document should be in writing, provide clear and straightforward terms, and be signed by both parties.

A negotiable instrument may be transferred to a third party — such as a collection agency or lawyer — in order to allow a lender to recoup its investment. When a borrower defaults on a debt, it is common for the lender to sell the negotiable instrument below market value to other lenders who attempt to collect the debt.

This page will highlight the various components of a negotiable instrument. These include the parties involved, instruments used to secure debt, and others.

Holder in Due Course

A holder in due course refers to a party who has accepted a negotiable instrument and exchanged something valuable for it. More simply, such a party “holds” a negotiable instrument, which in the case of real estate is a mortgage note.

It is common for lenders to sell mortgage debt to interested buyers prior to a borrower’s default on the debt as a way of protecting its financial interests, cutting financial losses before they get any worse or to make a profit. It is usually sold for less than the principal loan amount.

A holder in due course may purchase a note with the intent of collecting interest or foreclosing on the note and recouping payment through a foreclosure and subsequent sale. A note holder may sell the debt to another party to free up capital for new mortggae originationor to reduce liability from bad debt.

A holder of due course may purchase a negotiable instrument held by a lender, therefore becoming the new “lender”. This entitles the holder in due course to receive the borrower’s future payments. A holder in due course is granted superior protection to other governing or conflicting laws.

In the event that a borrower’s debt is sold, the lender is not required to give that borrower notice. Should a borrower pay the old lender not knowing of the transfer to the holder in due course, the wrongful payment must be transferred to the new lender. In this situation, payment to the old lender qualifies as a valid attempt by a borrower to make a payment.

Valid defenses against a holder in due course:

Incapacity: The seller of the debt lacked the capacity to sell the debt

Illegal: The transfer of the debt was illegal

Forgery: The transferee was forged and not the intent of the maker or payee

Alteration: Alteration of the terms of the sale without the approval of either party is illegal and serves as a valid defense

Promissory Note and Negotiable Instrument

A promissory note — sometimes known as a “note payable” or simply a “note” — is a signed document that contains a written record of the sum a borrower owes to a lender. A note protects the interests of a lender by establishing a clear record of debt.

A negotiable instrument is a type of note that can easily be sold or transferred,

Promissory notes are used in real estate by lenders, banks, and government lending agencies, such as Fannie Mae or Freddie Mac.

The provisions included in a valid promissory note depend on the terms of the agreement and the type of credit being extended. In general, however, a note includes:

Principal debt amount

Payment terms, including the amount that must be paid to stay current on the note and options on how to pay it off

The date on which the loan must be paid off

A note may include a monthly interest rate on the principal loan amount. If a borrower defaults on a debt, the lender may have the option to increase the interest rate.

A defeasance clause is a provision that cancels a debt upon the payment or settlement of the promissory note.

Negotiable Instrument

In order to use a negotiable instrument a promissory note:

Must be in writing

Is an agreement promising payment for a specific amount of money? Payments can be fixed or adjustable.

Is a promise to pay from one person to another or promise to pay a group, LLC, lender, banker, etc.

Must be signed by parties

A negotiable instrument is a document that states that a borrower owes a debt to a lender, therefore it protects the lender’s interest. The negotiable instrument is used as legal proof of a borrower’s debt and the promise to pay it back on a specified date or within a certain amount of days, weeks, or years.

Examples of negotiable instruments most commonly include promissory notes; however, negotiable instruments can also include bills of exchange, banknotes, and demand drafts.

If the promissory note adheres to the required standards, then the holder of the note can sell the note to other investors or bankers. The promissory note transfer gives the new holder the right to the property in the event the borrower fails to make payments assuming it is a first mortgage and there are no tax liens on the property. Some businesses specialize on buying and selling promissory notes.

The promissory note gives the note holder the right to sell or transfer the note at will. The new holder of the promissory note is known as the transferee.

Holder in Due Process

A holder in due process can take a negotiable instrument based on a few things. They are:

Take it for face value (value of the day)

Take it in good faith (not likely)

New note holder cannot enforce inaccurate information if:

The note was altered

The note was illegally changed or if illegal activity was involved

Note holder did not have legal capacity to make the agreement


Jon Barry and his wife Samantha buy a home. The full purchase price of the home was paid in cash. The Barry’s find a great investment property that they want to buy. Lacking the funds, Jon asks his mother for $200,000 and will use his home as collateral. His mother wants 5% interest on the money borrowed. John and Samantha agree and buy the investment property. John’s mother who wants her money back, sells the note to her sister, Mary, whom becomes the new note holder.

Aunt Mary finds out that current interest rates on the market are above 7% and decides that she wants to increase the Barry’s interest rate to 7.5% to reflect current market rates. John sends in his monthly mortgage payment which reflects the original 5% rate. Aunt Marry informs John to send the remaining balance (the difference between 5% and 7.5%) to bring the mortgage current. Confused, John informs her that she cannot change the interest on the loan. Who is correct? Can aunt Marry charge more interest on the loan?

No, she cannot change the interest rate on the loan. When an investor buys a note they cannot change the terms on the loan, unless already indicated in the agreement that the rate will increase in the future. Jon must only pay the original 5% without the risk of being foreclosed.