The difference between a mortgage and deed of trust is subtle. Both are used in bank loans and private loans. Both create a lien on real estate, both are considered, by law, evidence of a debt and both are generally recorded in the county in which the property is located. (A deed of trust is sometimes also referred to as a trust deed). Hard money lenders tend to operate more in trust deed states because the foreclosure laws are more flexible.
Private Loans | Private Money Lending
The difference between a mortgage and deed of trust is subtle. Both create a lien on real estate, both are considered, by law, evidence of a debt and both are generally recorded in the county in which the property is located. (A deed of trust is sometimes also referred to as a trust deed).
The difference between the two documents 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. Most times, it is state law that dictates whether a mortgage or a trust deed is recorded, but some states permit either document to be used.
Both documents secure repayment of a loan with real estate. So before delving into the differences between the mortgage and deed of trust, it will help to first define a promissory note (sometimes referred to as just “a note”) and understand its function relative to borrowing against real estate.
A promissory note is simply a promise to pay a debt at agreed upon terms. A promissory note is generally not recorded and contains details about the loan such as the maturity date, interest rate (i.e. fixed, variable, or some combination thereof), payment amount and frequency. A promissory note itself, however, is not secured by the real estate. To secure repayment of the promissory note with real estate, a lender uses either a mortgage or deed of trust. These documents are sometimes called “security documents” because they secure the promissory note to the real estate and create a permanent record in the county in which the real property is located. This recorded document puts the public on notice and creates “notice of the lien” to anyone who cares or has reason to research title to the property.
So what’s the difference?
There are two primary distinctions between a mortgage and a trust deed:
- The number of parties involved in the transaction and
- The procedure for enforcing the lien via foreclosure
Number of Parties
A mortgage involves two parties:
- The Borrower (the Mortgagor) and
- The Lender (the Mortgagee)
A trust deed involves three parties:
- Borrower (the Trustor)
- The Lender (the Beneficiary)
- The title company, escrow company, or bank (the Trustee) that holds title to the lien for the benefit of the lender and whose sole function is to initiate and complete the foreclosure process at the request of the lender.
A mortgage is enforced pursuant to a court supervised foreclosure process while a trust deed gives the lender (banks or hard money lenders) the option to bypass the court system altogether by following the procedures outlined in the trust deed and applicable state law. This is called a non-judicial foreclosure or trustee’s sale. If the trustee conducts a foreclosure sale, title is conveyed from the trustee to the new owner via a document called a Trustee’s Deed. If there are no bidders at the trustee sale, the property reverts back to the beneficiary (lender) and title is still transferred from the trustee to the lender using the Trustee’s Deed.
This process requires the lender to file a lawsuit in order to obtain a judgment. It is time consuming and expensive, but it does have an added benefit for the lender. If the lender doesn’t get enough money from the foreclosure auction to pay off the note, the can sue the borrower(s) for the remaining balance owed. This is known as a deficiency judgment. In some states, even if a trust deed was used as the security instrument lenders can elect to do a judicial foreclosure to preserve the option of a deficiency judgment. Hard money lenders would rather have a non-judicial process which is why more private loans are originated in trust deed states which are more friendly to private money lending.
A judicial foreclosure also provides a “right of redemption” to the borrower even after the property is sold at auction. This allows the borrower to repay the lender after the foreclosure sale (within a certain time frame), which varies by state, and reacquire title to the property.
This is becoming the most common process for foreclosure because it is faster and less expensive. Many states that have, in the past, been “mortgage” states have recently passed laws that allow for the use of trust deeds. With this non-judicial procedure the lender issues proper notices and follows certain rules, and then if the borrower doesn’t bring the loan current, the property goes to a trustee’s sale. Unlike a judicial foreclosure, once the property is sold the borrower has no right of redemption.
While the lender and/or state law will ultimately determine which security instrument is used to secure a loan, it is important for a prospective borrower to understand what he/she is signing, their rights as the borrower, and what the exact procedures are in the state where the property is located.