Key Takeaways
- A deed of trust is a type of security for a loan that names a third party called the
- “trustee” to hold the legal title until you pay it off.
- The trustee is typically an entity such as a title company with “power of sale” in the event that you default on your loan payment.
- In many states, you can have either a deed of trust or a mortgage, but not both.
- Unlike a mortgage, in the event of a default, the trustee has the power to sell the property without a court proceeding. This is called “nonjudicial foreclosure.”
Definition and Example of a Deed of Trust
A deed of trust is an agreement between you—the homebuyer—and your lender. It states that you’ll repay the loan and that a third party will hold legal title to the property until you do. This third party is known as the “trustee.”
A deed of trust is the security for your loan. It is recorded in the public records. If a state requires it, borrowers must agree to sign the deed of trust if they want to take out a home loan, just as they would have to do to sign a mortgage in another state.
How Does a Deed of Trust Work?
A deed of trust addresses three parties:
- The trustor, or obligor, who is the borrower
- The trustee, who holds “bare or legal” title (usually a title company)
- The beneficiary, who is the lender
The trustee doesn’t represent either the borrower or the lender. The trustee is typically an entity such as a title company that holds “power of sale” in the event that you default on the loan. Once the deed is paid in full, the trustee reconveys the property to the buyer.
A deed of trust includes most of the same information as a mortgage, including:
- The original loan amount
- A legal description of the property used as security for the mortgage
- The names of parties: trustee, trustor, and beneficiary
- The inception and maturity dates of the loan
- The provisions and requirements of the mortgage
- Late fees
- Legal process in the event of default (a “power of sale” clause)
- Acceleration and alienation clauses, which detail when a homeowner is considered a delinquent or when they can sell the home
- Riders such as prepayment penalties or the terms of an adjustable-rate mortgage
The trustee can file a notice of default in the event that the borrower does not pay according to the promissory note’s terms. The trustee can also swap in another trustee to handle the foreclosure itself, by filing a formal Substitution of Trustee in most cases.
Deed of Trust vs. Mortgage
When you take out a loan to purchase a home, you will sign a mortgage or a deed of trust. These terms may often be used interchangeably, but there are some important distinctions.
| Mortgage | Deed of Trust | |
|---|---|---|
| Used in all states. | Used in some states. | |
| Bank forecloses in the courts. | Nonjudicial foreclosure. | |
| Between borrower and lender. | Among borrower, lender, and trustee. | |
| Lender and borrower both have interest in the property until loan is paid off. | Trustee has legal title to the property until loan is repaid. |
Foreclosure
The trustee has the power to sell the property in the event of default, without a court procedure. This is called “nonjudicial foreclosure.” It’s a key difference between a deed of trust and a mortgage. With a mortgage, a bank must go through the court to initiate a foreclosure.
The trustee cannot complete the foreclosure until a certain amount of time passes from the notice of default. Some states allow a redemption period. In this case, the borrower has time to buy the property back after a nonjudicial foreclosure. Other states give borrowers the right to mediation before the foreclosure process begins.
State Laws
Some states don’t recognize deeds of trust. Some states allow mortgages or deeds of trust. Others allow for both. Consult with a real estate attorney about the legal options and requirements where you live.
Deed of Trust vs. Promissory Note
The deed of trust documents the terms of the debt, secured by the property. The promissory note is a separate document, although it often goes hand-in-hand with a deed of trust.
A promissory note is a promise to pay, signed by the borrower in favor of the lender. It contains the terms of the loan, such as the interest rate and payment obligations. Legally, both a mortgage and a deed of trust are types of promissory notes.
The promissory note is marked “paid in full” when the loan is paid off. It’s returned to the borrower along with a recorded reconveyance deed. The lender retains the promissory note during the term of the loan. The borrower has only a copy until the loan is paid off.
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