Disclaimer: This post contains references to products from one or more of our advertisers. We may receive compensation (at no cost to you) when you click on links to those products. Read our Disclaimer Policy for more information.
Securing a real estate transaction is often done through a mortgage, but a Deed of Trust may be used in some instances.
A Deed of Trust is different than a mortgage but serves essentially the same purpose.
What Is a Deed of Trust?
A Deed of Trust is a formal agreement set between the bank or mortgage lender, the home buyer, and an impartial third-party called a trustee.
The bank/lender provides the funds for the borrower to purchase the property, and the lender is given a promissory note for the loan. The trustee (third-party) retains the legal title to the home/property until the loan is paid off.
In some states, a deed of trust is used in place of a mortgage.
This agreement involves three parties; Trustor (the borrower), the Trustee (third-party who retains the title until the loan is paid), and the Beneficiary (lender or bank).
How Does a Deed of Trust Work?
In a Deed of Trust sale, the borrower gives the lender a promissory note (one or more), stating that the borrower promises to pay the loan.
This document will include all the details about the arrangement, including interest rates, payment schedule, names of everyone involved in the transaction, what happens if the borrower defaults on the loan, and the loan’s maturity date.
When the loan is paid in full, the promissory note is filed as paid, and the actual deed to the property is given to the buyer. During the time the loan is being paid off, this legal deed is kept with the third-party trustee.
The Trustor
In a real estate transaction, the Trustor is the borrower or buyer. The title to the property they are purchasing is held in trust while they meet the terms and conditions of the trust (loan transaction/promissory note).
While the trustor does not hold the title officially during this time, they (the borrower) get to live at the property and build equity as they make mortgage payments.
The Beneficiary
In this real estate transaction, the Beneficiary is the person or entity who has invested or funded the purchase.
The lender who provides the funds to purchase the property is the Beneficiary. Sometimes, an individual can be the Beneficiary if you have a contract with them to purchase the property.
The deed of trust is a guarantee to this Beneficiary that you will pay off the loan.
The Trustee
The Trustee holds the legal title when the trustor is paying the beneficiary payments on the contract.
This trustee is an impartial third party. In most cases, the trustee will have one of the following two duties:
- Pay the lender or Beneficiary the balance owed on the loan if and when the borrower/trustor sells the property before the loan is paid off in full. Any balance from the sale after the Beneficiary is paid goes to the trustor (their earned equity).
- If the loan is paid in full by the contract date or before, the trustee dissolves the trust and sends the official title to the trustor/borrower, completing the contract.
If the borrower does not meet the conditions of the promissory note and defaults on the mortgage loan, the trustee will sell the property to assist the Beneficiary in getting their investment back.
Deed of Trust vs. Mortgages
While both a deed of trust and a mortgage act as legally binding contracts for home buyers to purchase a property, there are significant differences between the two.
Differences
Foreclosure is the biggest difference between the two. If you default on your loan/promissory note, the way a foreclosure is structured will be different.
For a traditional mortgage, the lender (or online mortgage lender) will use courts to process a foreclosure. For a Deed of Trust, the foreclosure will be processed outside of the courts.
The amount of time and money it will cost the lender or Beneficiary in each scenario is also different.
A bank will take longer going through courts and incur more fees to take back the home and foreclose.
A beneficiary in a deed of trust will have a shorter and less expensive foreclosure process. If a state allows a deed of trust, a lender will usually opt for this as it is easier and cheaper for them to take back the investment/home.
Other differences include:
- Deeds of Trust are only available in certain states, while mortgages are used in every state.
- In a mortgage, both the borrower and lender have an equal interest in the property until the loan is paid. In a Deed of Trust, the trustor (borrower) has the equitable right to the property.
Similarities
These are legally binding agreements. Both a mortgage and a deed of trust follow state law. Some states only allow mortgage contracts and some only deeds of trust.
In Alabama and Michigan, both are allowed, but it’s the lender who decides which one you use.
Another similar factor is that both agreements allow for the lender or Beneficiary to pursue foreclosure if you don’t pay the loan or default on the contract. These processes are different, however.
Both a deed of trust and a mortgage are contracts that put a lien on your property.
What Does a Deed of Trust Include?
The parts of a Deed of Trust:
- Legal Property Description: Like a mortgage, the legal and full description of the property will be included on a Deed of Trust.
- Initial Loan Amount: This amount is the total and initial amount of money given to you by the Beneficiary to purchase the property, minus any down payments.
- Length of the Loan: This determines how much time and maturity date to pay off the loan amount. This is often between 8-30 years for a lender, but if it is an individual, it can be any time frame you both agree to.
- Loan Requirements: Any requirements set in the loan agreement will be included here. This includes if there are any mortgage insurance premiums to be paid, whether you need to use the home as a primary residence, and any potential prepayment penalties.
- Acceleration and Alienation Clauses: The acceleration clause would take effect if a borrower is delinquent in payments. This clause will have terms and would state when the lender can begin the steps to foreclose. An Alienation clause is also known as a due-on-sale clause. This allows the lender to receive the loan balance in full upon the sale of the property (so that someone else cannot assume or take over the loan) or if you transfer the property out of your name and into an LLC.
- Power of Sale Clause: This clause helps determine when a trustee can sell the property on behalf of the Beneficiary. Usually, this is because the borrower has defaulted on the payments. This clause will state how long and at what point the trustee can step in and sell the property to protect the Beneficiary’s investment.
Bottom Line: Deed of Trust
Depending on where you live, you may be offered a deed of trust instead of a mortgage for your real estate transaction.
It’s important to know how these two differ and carefully read your agreement’s terms and conditions.
While both acts similarly to secure the loan you are contractually obtaining, the functions will differ, specifically the foreclosure processes, rights, and terms.
Keep Reading:
