Note vs. Mortgage & Loan Mechanics

What you'll be able to do

• Distinguish the promissory note from the mortgage (the collateral instrument).
• Describe the four repayment patterns and how each one's payment and balance behave.
• Compute and interpret the two ratios lenders live by — LTV and DSCR.
• Value a seasoned loan in the secondary market and reason about prepayment and refinancing.

Prerequisite: Unit 1 (proforma & NOI) and Unit 0.2 (present-value math).

The note and the mortgage are two different things

• Promissory note — the contract that sets out the financial obligation: principal, interest rate, term and payment schedule. It is the debt.
• Mortgage (or deed of trust) — the legal instrument that pledges the property as collateral for the note. It is what gives the lender the right to foreclose if the borrower defaults.

You can sell the note (the cash-flow stream) separately in the secondary market; the mortgage follows it.

The two ratios lenders underwrite on

• Loan-to-Value (LTV) = Loan ÷ Property value. Caps how much they'll lend (e.g. 60–75%). Lower LTV = more equity cushion = safer.
• Debt Service Coverage Ratio (DSCR) = NOI ÷ Annual debt service. Measures how comfortably the property's income covers the loan payment. Most commercial lenders want ≥ 1.25×.

Usually, a loan must satisfy both tests — whichever binds first sets the maximum loan.

Sizing connects straight back to the Unit-1 proforma: Loan* = min{LTV × value, DSCR-loan}, with DSCR = PBTCF₁ / ADS and ADS = PMT × 12. The unit then builds two returns on this loan: the debt IRR (operating flows = ADS, reversion = OLB) and the equity IRR (operating flows = EBTCF, reversion = BTER).

Deeper dive — the loan vocabulary in Excel

This is the notation of important variables in Excel that you should know: PV = loan amount, i = annual rate, N = years (×12 for monthly), PMT = payment, FV = outstanding loan balance (OLB / balloon). The defining rule: when FV = 0 the loan is fully amortized; when FV > 0 there is a balloon at maturity. Most commercial mortgages carry a long amortization but have the option to prepay short term (e.g. a 25-year schedule ballooned in 5 or 10 years), so you compute PMT off the long schedule but the OLB at the shorter payoff date.

Worked example — payment and balloon

€2,000,000 loan, 8% annual rate, monthly payments. Three structures:

• 25-yr amortization, fully amortizing → PMT ≈ €15,436/mo, balloon €0.
• 25-yr amortization, 10-yr balloon → PMT stays €15,436, balloon (OLB at month 120) ≈ €1,615,266.
• 15-yr amortization, 10-yr balloon → faster amortization raises PMT to ≈ €19,113, balloon ≈ €942,625.

How each figure is calculated (try the live sheet below — edit any blue cell and the payment and balloon recompute instantly):

• The payment is the level monthly annuity that fully repays the loan over the amortization period: PMT = PMT(rate/12, amortization_years × 12, −loan). Over 25 years (300 months) → €15,436/mo; squeezing the same €2,000,000 into a 15-year (180-month) schedule raises the payment to €19,113/mo.
• The balloon is the balance still owed at the payoff date — the value of the payments that remain: Balloon = FV(rate/12, payoff_years × 12, PMT, −loan). When the payoff date equals the amortization period, the balance is €0. With a 10-year payoff on a 25-year schedule, €1,615,266 is still owed; the faster 15-year schedule has repaid more principal, so only €942,625 remains.