Deed of Trust: Meaning, How it Works, Benefits

Deed of Trust: Meaning, How it Works, Benefits

A deed of trust is a type of agreement document which is usually used in place of a mortgage agreement. It is also commonly referred to as a trust deed. Although now not as common as they were at one point, these are still mandatory in 20 US states, with a few mandating the use of both mortgages and trust deeds. A deed of trust can be used for any real estate transaction that has been financed by a lending authority. In this article we will understand it in detail.


What Is A Deed Of Trust

A deed of trust, as mentioned, is a document used for real estate transactions. In order to get a deed of trust, the transaction needs to be financed by a lender, whether a bank, credit union, or online lender.

The deed of trust itself contains details about the ownership of property and is used for transferring the legal title of the property onto the third party neutral organization. These can include banks or escrow companies, for example. These authorities hold the ownership title for the property until the loan has been paid off by the loan borrowers, and transfer the ownership onto the borrower once the loan is fully paid.

In short, through this document, the property in question is trusted to be held by a neutral third-party till the time the debt for its purchase has been completely repaid.

A key difference between a mortgage and a deed of trust is that a mortgage agreement is entered into between two parties: the lender and the borrower, whereas a deed of trust includes three parties: the lender, the borrower, and the deed holder.


Advantages Of A Deed Of Trust

From the perspective of the borrower or buyer of the property, a deed of trust does not really provide any advantage. However, for lenders, this is quite a useful tool as it makes the property collateral for the loan.

  • Quicker Foreclosure: As opposed to a mortgage loan, the terms of a deed of trust are more suitable for lenders for its straightforward foreclosure process. In a mortgage loan, the process of foreclosure is a judicial process that can extend for a long time. It can only be carried out under the supervision of the court. When a borrower defaults on the loan repayment, the lender needs to file a suit to begin the foreclosure process.

However, in the case of a deed of trust, the third-party holder (known as trustee) can put the property for auction through a trustee’s sale.

Also read: What Is a Mortgage? Types, How They Work

This process does not require any judicial intervention, but is typically dictated by the terms outlined in the trust deed and in accordance with the state law.


How Does A Deed Of Trust Work

A deed of trust is an instrument used to create a legal claim on the property for which the deed has been designed. Banks as well as private loan grantors can both leverage deeds to create these legal rights which make the property a collateral against the loan taken by a borrower to the purchase of said property.

So how exactly do they work? Let’s find out.

In order to create or enter into a deed of trust, the first requirement is securing a loan for a property. Depending upon which kind of lender you approach, whether a bank, credit union, or online lender, you need to complete a comprehensive application process.

Also read: Deed Of Trust: What It Is And How It Works

This process typically includes filling out a detailed application form, and providing extensive financial documentation that proves your creditworthiness. These documents can include income proof, employment proof, bank statements, credit score, and more.

After the loan has been secured (which may or may not be a mortgage loan), it means that the property can be classified as a financed one. This is a basic requirement for a deed of trust. Once the loan has been secured, the borrower would provide promissory notes to the borrower. There may be one or more than one promissory notes involved for a deed of trust agreement.

The promissory note details the basic terms of the debt, along with a written promise that the borrower will pay off a specific amount of money to the other party, in a definite amount of time. The note reveals details about the duration of the loan, principal amount, rate of interest, payment schedule, and signatures of both parties.

This deed of trust, which is now created, is entrusted to a third party, known as the trustee who holds the legal title to the property for the duration of the loan term. This third-party needs to be an impartial party in order to ensure they do not unfairly favor one party over another. Moreover, the third-party holds the property in question as collateral for the fulfillment of the promissory notes. 

It is important to note that while the third-party holds the property, throughout the loan repayment phase, the right to full ownership of the property and that of its equitable title, usage and responsibility stays with the borrower. The borrower is not barred from using the property during this period.

As long as the loan repayment term continues, the borrower can keep using the property normally, as long as they continue to make their monthly payments on the loan. Once the debt has been paid off by the borrower completely, the title on the property becomes theirs, and they are completely free of any obligation and worry. At this point, the borrower is no longer chained to the lender or the third-party holder.

In case of payment default, however, the trustee can move forward with property sale according to the terms of the deed of trust.

A deed of trust is typically used as an alternative to a mortgage, however, some states require borrowers to get both. Depending upon the state where you reside, you may need to enter into a deed of trust mandatorily, or not at all. This can be a very useful instrument for borrowers in some rare cases, however, mostly, it is only a better option from the lender’s perspective.