Trust Deed: Definition, Process, Example Form

Definition

A trust deed, also called a deed of trust, is a document used in real estate transactions in the U.S. It comes into play when one party takes out a loan to purchase a property. The trust deed represents an agreement between the borrower and a lender to hold the property in trust by a neutral third party until the loan is paid off.

Trust deeds are less common than mortgages but are still mandated in 20 states during real estate financing. These states include Alaska, Arizona, California, Colorado, Idaho, Illinois, Mississippi, Missouri, Montana, North Carolina, Tennessee, Texas, Virginia, and West Virginia.

Some states, such as Kentucky, Maryland, and South Dakota, allow the use of both trust deeds and mortgages.

Key Takeaways

• In real estate transactions, trust deeds transfer the legal title of a property to a third party, such as a bank or title company, until the borrower repays their debt.
• Trust deeds are used in place of mortgages in several states.
• Investing in trust deeds can provide a high-yielding income stream.

Process

A trust deed involves three parties:

• Lenders, also known as beneficiaries, who have interests to protect.
• A borrower, or trustor, who establishes the trust.
• A trustee, a third party who holds the entrusted property until the loan is fully paid.

In a real estate transaction, a lender gives money to the borrower in exchange for promissory notes linked to a trust deed. The trust deed transfers the legal title of the property to an impartial trustee, such as a title company or bank, who holds it as collateral for the promissory notes. The borrower retains equitable title and full use of the property.

This arrangement continues until the borrower repays the debt in full. If the borrower defaults on the loan, the trustee takes control of the property.

Trust Deed vs. Mortgage

Trust deeds and mortgages create liens on real estate, but they have some differences.

Number of Parties

A mortgage involves two parties: a borrower and a lender. The borrower pledges the property as security.

Trust deeds involve three parties: a borrower, a lender, and a trustee. The trustee holds title to the lien for the lender’s benefit and initiates foreclosure if the borrower defaults.

Type of Foreclosure

Foreclosure procedures differ between trust deeds and mortgages. Trust deeds have a non-judicial foreclosure process, while mortgages require a court order for judicial foreclosure.

Non-judicial foreclosures are faster and less expensive for lenders, making trust deeds preferable in states that allow them.

In contrast, a mortgage is not a loan to buy a property; it pledges the property as collateral for the loan.

Contents of a Trust Deed

A trust deed includes:

• The borrower, lender, and trustee’s identities
• A full property description
• Restrictions on property use while in trust
• The loan terms, including principal, payments, and interest rate
• Late fees and penalties for repayment

A trust deed also includes a power of sale clause, which allows the trustee to sell the property if the borrower defaults.

Foreclosures and Trust Deeds

Foreclosure processes differ between mortgages and trust deeds. Mortgages have a judicial foreclosure process through the courts, while trust deeds have a non-judicial foreclosure process outlined in the trust deed and state law.

In a non-judicial foreclosure, the trustee can proceed with foreclosure without involving the court system. The property is then either sold at auction or reverts to the lender.

After a sale, the trustee pays the lender and borrower the respective proceeds. The borrower has no right of redemption.

Pros and Cons of Trust Deed Investing

Investing in trust deeds provides a high-yielding income stream but has some downsides.

• Pros: high-yielding income stream, portfolio diversification
• Cons: illiquidity, no capital appreciation

Investors should consider the risks and potential legal entanglements before investing in trust deeds.

Real-World Example

An example trust deed document used in Austin County, Texas, includes requirements for lenders. The form covers borrower and lender information, loan amount, and property address.

Additional sections specify terms for payment, escrow funds, liens, insurance, structure maintenance, and occupancy requirements. The borrower, notary, and witnesses must sign the document.

Assignment and Reconveyance in Trust Deeds

"Assignment" in real estate law refers to the transfer of a trust deed from one party to another, typically when the beneficiary sells their loan to another lender.

"Reconveyance" means transferring a property from a lender or trustee to a borrower, usually after the terms of a mortgage or loan are fulfilled.

Trustee Requirements

Some states have specific requirements for who can act as a trustee in a trust deed. Banks, credit unions, title insurance companies, attorneys, and authorized companies can serve as trustees in these states. Other states allow anyone to be a trustee.

The Bottom Line

Trust deeds are an alternative to mortgages in certain states. They involve a lender, borrower, and trustee, and the title of the property is held by a third party until the debt is repaid. Investing in trust deeds can provide high yields but carries risks and limitations.