A trust deed, also known as a deed of trust, is a crucial document often used in real estate transactions in the U.S. This document plays a vital role when one party takes out a loan from another to purchase property. A trust deed represents an agreement between the borrower and a lender to have the property held in trust by a neutral and independent third party until the loan is paid in full.
While trust deeds are less common today, about 20 states still mandate their use over mortgages when financing real estate. States like Alaska, Arizona, California, and Texas, among others, frequently use trust deeds. Some states such as Kentucky, Maryland, and South Dakota allow the use of both trust deeds and mortgages.
Key Takeaways
- In financed real estate transactions, trust deeds transfer the legal title of a property to a third party (e.g., a bank or escrow company) until the borrower repays their debt.
- Trust deeds are often used in place of mortgages in various states.
- Investing in trust deeds can offer a high-yielding income stream.
The Key Players in Trust Deeds
A trust deed involves three parties:
- Lenders, officially known as beneficiaries, who are the entities the trust aims to protect.
- Borrowers, or trustors, who establish the trust.
- Trustees, third parties responsible for holding the property in trust until the debt is repaid.
For instance, in a real estate purchase, a lender provides money to the borrower in exchange for promissory notes linked to a trust deed. This deed transfers the legal title to an impartial trustee (typically a title company, escrow company, or bank) as collateral. The borrower keeps the equitable title and the right to full ownership upon debt repayment. However, should the borrower default, the trustee gains full control over the property.
Trust Deeds vs. Mortgages: A Clear Distinction
Number of Parties
- Mortgages: Involve two parties—borrower (mortgagor) and lender (mortgagee).
- Trust Deeds: Involve three parties—borrower (trustor), lender (beneficiary), and trustee.
Foreclosure Process
- Mortgages: Lead to judicial foreclosure, where a court order is required.
- Trust Deeds: Generally use non-judicial foreclosure, facilitated by a power-of-sale clause.
Judicial foreclosures are more costly and time-consuming, making trust deeds a preferable choice for lenders in states where they are allowed.
Components of a Trust Deed
A deed of trust includes key elements such as:
- Identities of the borrower, lender, and trustee.
- A detailed description of the property in trust.
- Terms of the loan, including principal, repayments, and interest rate.
- Restrictions or requirements related to property use during the trust period.
- Provisions for late fees and penalties.
- Power of sale clause, allowing the trustee to sell the property if the borrower defaults.
Foreclosure Process Under Trust Deeds
Trust deeds and mortgages differ significantly in foreclosure processes. A judicial foreclosure, triggered by a mortgage default, involves a costly and lengthy court procedure. Conversely, a trust deed enables a faster, less-expensive non-judicial foreclosure process.
In non-judicial foreclosure, as outlined in the trust deed and state laws, if the borrower defaults, the trustee initiates a trustee’s sale, auctioning off the property. The trustee handles the sale proceeds, repaying the lender and returning any surplus to the borrower.
Investing in Trust Deeds: Pros and Cons
Investors often seek high yields through trust deed investments where money is loaned to developers working on real estate projects. The investor’s name appears on the trust deed as the lender, collecting interest on the loan until the principal is returned in full post-project completion. Typically, a broker arranges this.
Pros:
- High-yielding income stream.
- Portfolio diversification.
Cons:
- Illiquidity of investment.
- No capital appreciation.
Developers, who might face challenges in obtaining speedy loans from traditional banks, often turn to trust deed investors for their projects, offering high-interest rates and portfolio diversification opportunities.
Practical Example of a Trust Deed
A deed of trust document, like the standard form used in Austin County, Texas, entails details such as borrower, lender, and trustee information, loan amount, and property address. It covers payment, insurance, and residency covenants as well as nonuniform covenants specifying default conditions. The document finalizes with signatures from the borrower, a notary, and witnesses.
Additional Concepts: Assignment & Reconveyance of Trust Deeds
Assignment
Assignment involves transferring a trust deed from one party to another, typically when a lender sells the loan.
Reconveyance
Reconveyance refers to the transfer of a property back to the borrower after fulfilling loan terms, marked by the completion of both mortgage and trust deed terms.
The Role of Trustees
Some states restrict who can act as trustees to entities like banks, credit unions, and attorneys, while others have no such limitations.
Conclusion
Trust deeds offer a valuable alternative to mortgages in specific states by involving a third-party trustee to hold the property title until the borrower’s debt is cleared. They provide high-yielding opportunities but come with challenges such as illiquidity and the need for expert guidance in real estate investments.
Understanding the intricacies of trust deeds can empower investors and real estate enthusiasts to make more informed and strategic decisions.
Related Terms: Mortgage, Lien, Promissory Note, Foreclosure, Deed of Reconveyance.
References
- Rocket Lawyer. “Which States Allow Deeds of Trust?”
- Legal Information Institute. “Non-judicial Foreclosure”.
- Legal Zoom. “Naming a Trustee in Your Deed of Trust”.
