What is a Trust Deed ?
A trust deed, also known as a deed of trust, is a document that is occasionally used in U.S. real estate transactions. It is a document that comes into play when one party borrows money from another to purchase real estate. The trust deed represents an agreement between the borrower and the lender to have the property held in trust until the loan is repaid by a neutral and independent third party.
Twenty states still require the use of a trust deed rather than a mortgage when financing the purchase of real estate, despite the fact that trust deeds are less common than they once were. Alaska, Arizona, Illinois, Illinois, California, Colorado, Idaho, Mississippi, Missouri, Montana, North Carolina, Tennessee, Texas, Virginia, and West Virginia are states where trust deeds are prevalent.
A handful of states, including Kentucky, Maryland, and South Dakota, permit both trust deeds and mortgages.
• In financed real estate transactions, trust deeds transfer the legal title of the property to a third party, such as a bank, escrow company, or title company, for safekeeping until the borrower repays the lender's debt.
Several states use trust deeds instead of mortgages. Investing in trust deeds may provide a high-yielding income stream.
Understanding Trust Deeds
A trust deed is an agreement involving three parties:
• Lenders, formally referred to as beneficiaries. These are the interests that a trust is intended to safeguard.
• A borrower, also referred to as a trustor. This is the individual who creates a trust.
• A trustee is a third party entrusted with holding property until a loan or debt is repaid in full.
In a real estate transaction, such as the purchase of a home, the lender provides the borrower with funds in exchange for one or more promissory notes that are secured by a trust deed. This deed transfers legal title to the real property to a neutral trustee, typically a title company, escrow company, or bank, who holds the property as collateral for the promissory notes. The borrower retains equitable title, or the right to acquire full ownership, as well as full use of and responsibility for the property.
This circumstance persists throughout the loan's repayment period. The trustee holds the legal title until the debt is repaid in full, at which point the borrower receives ownership of the property. In the event that the borrower defaults on the loan, the trustee assumes full ownership of the property.
Trust Deed vs. Mortgage
Both trust deeds and mortgages are used to create liens on real estate for bank and private loans, and both are typically recorded as debt in the county where the property is situated. Nonetheless, there are some distinctions.
Number of Entities
Two parties are involved in a mortgage: the borrower (or mortgagor) and the lender (or mortgagee). When a borrower signs a mortgage, the property is pledged to the lender as collateral to ensure repayment.
A trust deed, on the other hand, involves three parties: the borrower (or trustor), the lender (or beneficiary), and the trustee. In case the borrower defaults, the trustee will initiate and also complete the foreclosure process at the lender's request.
Types of Foreclosure
A deed of trust will lead to different foreclosure procedures than a mortgage in the event of default. A mortgage default will result in a judicial foreclosure, which requires the lender to obtain a court order. Trust deeds are subject to a non-judicial foreclosure if they contain a power-of-sale clause.
Compared to non-judicial foreclosures, judicial foreclosures are more costly and time-consuming. This means that, from the lender's perspective, a deed of trust is preferable to a mortgage in states that permit them.
Contrary to popular belief, a mortgage is not technically a loan to purchase a property; rather, it is an agreement in which the property is pledged as collateral for the loan.
What Constitutes a Trust Deed?
• The identities are the borrower, lender, and trustee
• The description of the property to be placed in trust
• Any restrictions or requirements regarding the use of the property while it is in trust
• The terms of the loan, including the principal, monthly payments, and interest rate
• The terms of any delayed fees and penalties in the event of repayment failure
Additionally, a trust deed will contain a clause granting the trustee the authority to sell the property if the borrower defaults.
Foreclosures and Trust Deeds
The foreclosure processes for mortgages and trust deeds vary. When the lender files a lawsuit against the borrower for mortgage default, a judicial foreclosure is a court-supervised procedure. This procedure is time-consuming and costly.
In addition, if the auction of the foreclosed property does not generate sufficient funds to pay off the promissory note, the lender might very well file a deficiency judgment against the borrower and sue for the remaining balance. However, even after the property has been sold, the borrower retains the right of redemption: They may repay the lender within a predetermined time frame and reclaim the property title.
In contrast, a trust deed permits the lender to initiate a quicker and less costly non-judicial foreclosure, bypassing the court system and adhering to the trust deed's and state law-outlined procedures. The property is put up for auction by a trustee if the borrower fails to keep the loan current.
After the sale, the trustee's deed transfers title from the trustee to the new owner. The property reverts to the lender through a trustee's deed if there are no bidders at the trustee sale. Once the property has been sold, there is no right of redemption for the borrower.
In addition, a trustee is responsible for distributing the sale proceeds to the borrower and lender after the sale has been completed. The trustee will pay the lender the amount remaining on the debt and pay the borrower the excess, allowing the lender to acquire the property.
Trust Deed Investing: Pros and Cons
When searching for enticing returns, investors sometimes turn to the real estate industry, and trust deeds in particular.
The investor lends money to a developer working on a real estate project in trust deed investing. The name of the investor appears on the deed of trust as the lender. The investor receives interest on his loan, and his principal is returned to him in full when the project is completed. Typically, a trust deed broker facilitates the transaction.
Pros
• High-yielding income stream
• Diversification of the portfolio
Cons
• Illiquidity
• No capital appreciation
Which type of developer enters into this agreement? Banks are frequently hesitant to lend to certain types of developments, such as commercial projects of medium size — too small for the large lenders and too large for the small lenders — or to developers with a poor track record or too many loans. Additionally, cautious lenders may move too slowly for developers who are up against a tight deadline to initiate or complete a project.
These developers are frequently in a time crunch. For these reasons, investors in trust deeds can frequently anticipate high rates of return on their capital. They can benefit from diversifying into a different asset class without needing to be experts in real estate development or management: This investment is a passive one.
Investing in trust deeds involves risks and disadvantages. In contrast to stocks, real estate investments are illiquid, meaning that investors cannot withdraw their funds on demand. In addition, investors can anticipate only the interest that the loan generates; capital appreciation is unlikely.
Invested parties may exploit any legal inconsistencies in the trust deed, resulting in expensive legal complications that may jeopardize the investment. Finding credible and trustworthy developers, projects, and brokers can be challenging for the typical investor with little experience, as it requires specialized knowledge.
Trust Deed – Real World Example
A short form deed of trust used in Austin County, Texas, meets the needs of the majority of lenders. The form begins with a glossary of terms and blanks for the names of the borrower, lender, and trustee. The amount borrowed and the property's address are also required.
Following this section, the document specifies the transfer of property rights and uniform covenants, including:
• Information about principal and interest payments
• Property insurance and structure maintenance
• Liens
• Escrow funds
• Structure occupancy specifying that the borrower must occupy the property within sixty days
In addition to uniform covenants, the form includes non-uniform covenants that specify default or violation of any of the agreement's terms. And it specifies that the loan in question is not a home equity loan, i.e., one from which the borrower will receive cash, but rather a loan for the purchase of the property.
The deed of trust concludes with a space for the borrower's signature, which must be witnessed by a notary and two witnesses.
FAQs
What Is Assignment in a Trust Deed?
In real estate law, the term "assignment" refers to the transfer of a trust deed from one party to another. Typically, this occurs when the beneficiary of a trust deed sells his or her loan to another lender.
What Is Reconveyance in a Trust Deed?
In real estate law, reconveyance refers to the conveyance of property from a lender or trustee to a borrower. This typically occurs at the conclusion of a mortgage or other loan, when the terms of the debt have been satisfied.
Who May Serve as a Trustee in a Trust Deed?
Some states have laws that restrict who can serve as a trustee in a trust deed. In these states, the trustee must be a bank, credit union, thrift, title insurance company, attorney, or other institution with the authority to hold a trust. In other states, any individual may serve as a trustee.
The Bottom Line
In certain states, trust deeds are an alternative to mortgages. A trust deed places the title of a property in the hands of a third party, or trustee, as opposed to a direct agreement between a lender and a borrower. The property will be fully transferred to the borrower only after the borrower has satisfied the terms of their debt to the lender.