The term “mortgage” is used whenever a person buys a home with a loan, but it’s not always the right terminology. Some states do not use mortgages. Instead, they use a document known as a deed of trust, a legally binding contract for a real estate transaction.
Anyone buying a home should understand what a deed of trust is and how it differs from a traditional mortgage.
What is a deed of trust?
There are three parties in a deed of trust: the lender, the homebuyer or borrower, and a trustee. The trustee is a third party who plays the role of intermediary for the real estate transaction. This is unlike a mortgage, in which there are just two parties involved: the lender and the borrower.
With a deed of trust, the lender gives the borrower the funds to make the purchase. The borrower provides the lender with a promissory note. The promissory note outlines the terms of the loan and the borrower’s promise to pay. At this point, the borrower transfers the real property interest to the trustee. The “real property interest” is simply a term used to describe the right to that real estate property.
Here’s why that matters. Because the trustee holds the interest in the real estate, the trustee can take action if the borrower fails to make payments on time or fails to follow all that was agreed to in the promissory note.
If the borrower stops paying the loan, for example, the trustee has the legal right to take full control of the property. The trustee’s job is to correct the default. To do this, the trustee may have to sell the home to repay the borrower.
Additionally, the rights and processes for the trustee to follow are not the same in every state. In some situations, the trustee merely holds the lien on the property and is given only a few rights in terms of handling defaults on the loan.
Deed of trust vs. mortgage
In a traditional mortgage, the borrower agrees to the terms of the loan from the lender. If the borrower defaults on the mortgage loan, the lender has the legal right to start the foreclosure process. In states where a mortgage is used, the foreclosure process is generally done in a court of law. Foreclosure is a lengthy process that tends to be costly because of legal fees.
Deed of trust foreclosures
Under a deed of trust, the property can be sold if the borrower is in default without going through a costly legal procedure. The process is known as a nonjudicial foreclosure.
The deed of trust allows the trustee to maintain the controlling interest in the property until the debt is paid in full. Any deed of trust with a power-of-sale clause, which is nearly always present, allows the trustee to sell the home without needing to foreclose on it first.
Deed of trust transfers
Deed of trust transfers operate similarly to mortgage transfers, though neither one is especially common. Whether buying a house with a deed of trust or a mortgage, the transferee will most likely need to enter into a new arrangement as part of the sale. However, in certain circumstances, like a property owner’s death, divorce or living will proceeding, both mortgage and deeds of trust can be transferred. The appropriate authorities (usually a municipal government) will have to record the transfer, just like they would for a purchase agreement.
Which states use deeds of trust?
Deeds of trust are used or allowed in 34 states and the District of Columbia. Some of those also permit both mortgages and deeds of trust. In these situations, the terms of the mortgage agreement and promissory note will outline what the ultimate contract requires.
How does a deed of trust impact you?
Anyone buying a home with a deed of trust should know that the home can be foreclosed quickly, without any legal proceeding in a court of law. In other words, there may not be an opportunity to get caught up on the loan.
Homebuyers or others taking on a new mortgage loan should take the time to find out whether they have a mortgage or a deed of trust. In many cases, this will dictate how any legal proceedings will be carried out if the terms of the contract are breached.