What it means
Cornell's Legal Information Institute describes a deed of trust as a type of secured real estate transaction that some states use instead of mortgages. The lender gives the borrower money, and in exchange the borrower gives the lender one or more promissory notes.
As security for the notes, the borrower transfers a real property interest to a third party trustee, who is usually a title company. If the borrower defaults, the trustee may take control of the property to correct the default.
The details of the transfer vary: in most states the borrower transfers legal title to the trustee, who holds the property in trust for the benefit of the lender, while in other states the trustee holds only a lien on the property. The feature that most affects borrowers is foreclosure.
LII notes that deeds of trust almost always include a power of sale clause, which lets the trustee run a non-judicial foreclosure, meaning a sale of the property without first getting a court order. The Consumer Financial Protection Bureau says the home loan security document may be called the Security Instrument, Deed of Trust, or Mortgage.
By signing it, you give the lender the right to take your property by foreclosure if you fail to pay as agreed. It restates basic information in the promissory note and explains the borrower's responsibilities and rights.
The CFPB explainer points to a section on default. If you miss payments or break other conditions, such as keeping homeowners insurance, the lender can declare the loan in default and demand repayment in full.
If you cannot pay, the lender can start foreclosure. The name on your paperwork depends on where the property is, and state law sets which instrument applies and the exact foreclosure steps.
Read the document you sign and ask a local lawyer or a housing counsellor about your state's process.
In practice
Real-world examples.
Example
In a fictional home loan, the borrower buys a house, the lender is a bank and the trustee is a title company. The borrower pays the bank each month. If the borrower defaults, the title company can start a non-judicial foreclosure as the bank's agent.
Example
A fictional borrower signs a promissory note and a deed of trust for $250,000. The note is the promise to repay, and the deed of trust secures it with the property. If the borrower stops paying, the trustee can act under the power of sale.
Example
A fictional borrower moves to a state that uses mortgages instead. Her new loan security document is called a mortgage, but it does the same basic job of securing the loan with the property.
Formula
Calculation
There is no formula. A simple balance check: a $250,000 loan at 80% loan to value means a property worth $250,000 / 0.80 = $312,500. Check: $312,500 x 0.80 = $250,000.Case study
Seen in the real world.
This case study is fictional and illustrative. Priya buys a house for $312,500 with a $250,000 loan. At closing she signs a promissory note and a deed of trust that names a title company as trustee. She reads the section on default.
It says that if she misses payments or lets her homeowners insurance lapse, the lender can declare the loan in default. The lender can then demand the full balance. Two years later, a job loss causes her to miss several payments. She calls the lender early and asks about options.
Because the deed of trust includes a power of sale, she knows the trustee could begin a non-judicial foreclosure if the default continues, so she acts quickly. The lesson is that the document is not paperwork to skim. It tells you what counts as default and how the lender can act, so read it before signing.
Watch out
Common mistakes.
- Assuming a deed of trust is a different kind of debt, when it secures a loan in a way some states use instead of a mortgage.
- Ignoring the default section, when it sets out when the lender can demand full repayment and start foreclosure.
- Assuming foreclosure always goes through a court, when a power of sale clause can allow a sale without a court order.
Questions
People also ask.
What is a deed of trust?
It is a secured real estate loan arrangement used in some states instead of a mortgage. It involves a lender, a borrower and a trustee.
Who is the trustee?
A third party who holds an interest in the property as security. Usually it is a title company.
How is a deed of trust different from a mortgage?
A deed of trust adds a trustee as a third party, and it usually allows non-judicial foreclosure through a power of sale. Which one you use depends on state law.
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