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What Is a Deed of Trust?
A deed of trust, also called a trust deed, is a legal agreement made at a property's closing. It is a type of secured real estate transaction used in some states in place of a mortgage. The individual purchasing a property and a lender make this agreement, which states that the property buyer will repay a loan. A third party, known as a trustee, holds the property's legal title until the loan gets paid in full.
A deed of trust is the security for a loan and gets recorded in public records. Some states will require a borrower to sign a deed of trust to take out a home loan, much like other states require signing a mortgage. Fundamental differences exist between deeds of trust and mortgages, however. For example, a deed of trust requires more people to be involved in the property sale than a mortgage would. Only a mortgage gets executed through the judicial system.
What Must a Deed of Trust Include?
To be considered a legally binding document, any deed of trust needs to cover several critical details. Required information includes the following:
- Original loan amount
- Description of the property used as collateral or security ( here is an article about using collateral for a loan)
- Names of all parties involved (such as trustor, beneficiary, and trustee)
- The inception date of the loan
- The maturity date of the loan
- Any fees, such as late fees
- Provision and requirements of the mortgage
- Legal procedures in case of default, such as a power of sale clause ( here is an article about power of sale)
- Acceleration and alienation clauses to explain when the homeowner is considered delinquent or what happens when the individual sells the property
- Any riders with clauses such as terms of an adjustable-rate mortgage or prepayment penalties
Who Is Involved With a Deed of Trust?
Three parties must be involved with any deed of trust:
- Trustor: This party is the borrower. A trustor is sometimes called an obligor.
- Trustee: As a third party to a deed of trust, the trustee holds the property's legal title.
- Beneficiary: This party is the lender.
A trustee represents neither the borrower nor the lender. Instead, the trustee is an entity that holds the power of sale in case a borrower defaults. The trustee is typically a title or escrow company.
How Does a Deed of Trust Work?
A borrower gives a lender one or more promissory notes in exchange for the deed of trust. Promissory notes are documents that the borrower signs which state the borrower's promise to pay back a debt. The promissory note will contain information such as the interest rate along with other obligations of the agreement.
After the borrower pays the deed in full, the trustee will reconvey the property to its buyer. A promissory note is marked as paid in full once the buyer pays the loan entirely, and the property buyer receives the deed.
A trustee may file a notice of default if the borrower does not pay following the terms of the promissory note. A trustee may also substitute a different trustee for handling foreclosure.
Deed of Trust Versus Mortgage
A deed of trust and a mortgage serve a similar purpose, but some key distinctions exist between the two types of legal documents.
Differences Between Deeds of Trusts and Mortgages
Significant differences between the two documents include the following:
- Foreclosure type: The foreclosure type a property owner faces will depend on whether the property owner has a deed of trust or mortgage. Someone who has a deed of trust typically faces a nonjudicial foreclosure, while a lender will need to go through the courts if a mortgage comes into play.
- Expense and length of foreclosure process: Since a lender will have to seek judicial foreclosure to take back a property using a mortgage loan, a mortgage generally takes more money and time for foreclosure proceedings. As a result, mortgage lenders tend to use deeds of trust in states that allow them. A lender will almost always spend less time and incur lower costs reclaiming a property when using a deed of trust instead of a mortgage.
- Parties involved: Only two parties, a borrower and a lender, are engaged in a mortgage contract. A deed of trust has a trustee, the neutral third party, involved in addition to the borrower and lender.
Similarities Between Deeds of Trusts and Mortgages
The two agreements also have a few significant similarities, including:
- Both agreements are distinct from loans: Neither a deed of trust nor a mortgage is a home loan. The loan states that a property owner will pay back a set amount of money to a lender, while both a deed of trust and a mortgage place a lien on a property.
- Both agreements allow for foreclosure: Both a deed of trust and mortgage give a lender a method of taking back a property via foreclosure. These agreements essentially state that if the borrower does not follow the loan terms, the lender can put the property into foreclosure.
- State law dictates both types of agreements: Both mortgages and foreclosure deeds are subject to state laws. The specific type of contract a lender must use will depend on what is legal in a particular state.
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Deed of Trust Versus Promissory Note
A deed of trust often requires a promissory note, but the promissory note is a specific document type. While a deed of trust describes the terms of debt as secured by a property, a promissory note acts as a promise that the borrower will pay the debt.
A borrower signs the promissory note in favor of a lender. The promissory note includes the loan's terms, such as payment obligations and the loan's interest rate. However, although the promissory note is usually a separate document, both a deed of trust and a mortgage can be legally considered a type of promissory note.
During the term of a loan, a lender keeps the promissory note, and the borrower only has a copy of the note. Once the borrower pays off the loan, the promissory note is marked as "paid in full." Then, the borrower receives the note with a recorded reconveyance deed.
Can You Use a Deed of Trust Anywhere?
State law governs the use of both deeds of trust and mortgages. Some states only legally allow mortgages, while other states only allow lenders to use deeds of trust. A few states will allow either type of contract. In these states, the lender gets to choose the type of agreement a borrower receives. Some states use neither mortgages nor deeds of trust but instead use other contracts such as security deeds for loan transactions to give lenders a security interest in the property.
Since state laws vary regarding the type of document you can use, it's always essential to consult with an experienced lawyer to discuss legal options and your state's requirements. A lawyer can also help ensure that you create and use a legally binding document that protects you in your specific situation regarding real estate transactions for residential or commercial property.
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