When borrowers take out a loan for a property, they have to sign a promissory note--a document pledging to repay the loan. Depending on where the transaction takes place, this document could be either a mortgage note or a deed of trust. The main difference between the two is in who holds the title to the property while the borrower is paying off the loan.
Both are used by banks and private lenders to create liens on real estate, and are considered, by law, evidence of a debt as they are generally recorded in the county in which the property is located. Hard money lenders, like Ignite Funding, tend to operate more in trust deed states because the foreclosure laws are more flexible in the case of the borrower defaulting and the lender having to take back the property.
First Trust Deed Position
A first trust deed has priority over all other mortgages or trust deeds. This simply means that the first trust deed was recorded before any other liens, encumbrances or trust deeds involving a property. Priority is important because if a lender forecloses on a first trust deed, then all other trust deeds disappear, and the lender takes the property free and clear.
Mortgage vs. Deed of Trust: The Similarities
Both documents function in the same way. Each secure repayment of the loan by placing a lien on the property. A lien gives rights to the lender that, unless the property is paid in full, the lender has a right to sell that property. In other words, both documents are used to make sure the borrower pays back the loan. Both documents allow the person or entity named as the lender/investor to sell the property if the borrower cannot meet the terms of the loan. In the case of a hard money lender, the lender would foreclose on the property. Once the lender takes the property through foreclosure, the investors on the deed of trust own the property and can sell to a new buyer. Selling the property may allow the investors to recoup their original principal and sometimes earn a capital gain, as well, depending on the sale price achieved.
Mortgage vs. Deed of Trust: The Differences
The difference between a mortgage and a deed of trust relates to the number of parties involved in the lien transaction, the name of the documents, and the method of foreclosure that is used if the underlying debt is not paid per the terms of the loan agreement. In most states, law dictates whether a mortgage or a trust deed is recorded, but some states permit either document to be used.
Mortgage vs. Deed of Trust: Number of Parties Involved
A mortgage involves two parties: a Borrower (the Mortgagor) and a Lender (the Mortgagee). A trust deed involves three parties: a Borrower (the Trustor), a Lender or investor (the Beneficiary), and the title company or escrow company (the Trustee) that holds title to the lien for the benefit of the lender(s) and whose sole function is to initiate and complete the foreclosure process at the request of the lender.
What Happens When the Borrower Can’t Pay?
In a mortgage state, if the borrower can’t pay, the foreclosure process and the selling of property must go through the courts. This is known as judicial foreclosure and the process involves the lender filing a lawsuit. This can be a costly process for both the borrower and the lender.
In a deed of trust state, courts can be bypassed. This is known as non-judicial foreclosure and it’s almost always faster and less costly. How this process happens is based on both state laws and the terms and procedures laid out in the deed of trust.
Why Invest in Trust Deeds?
Trust deed investing is simply investing in loans secured by real estate. Most trust deed investments are relatively short term loans made to real estate investors. Trust deed investments offer an attractive yield with relatively low risk. Trust deed investors can earn high single-digit annual returns and in some cases double-digit returns that are paid monthly. These returns are very favorable and are comparable to other investment options with similar risk profiles. The risk of losing money in a trust deed investment is mitigated by a built in “margin of safety,” because the investment is secured by REAL property.