There are some twenty states in which buyers cannot finance real estate acquisitions with mortgages. Instead, they utilize trust deeds. Both are instruments that govern the rules of borrowing and lending, and both confer rights and responsibilities to all parties involved. But the one key difference between trust deeds and mortgages is the deed holder.
In simple terms, a mortgage is a contract between two parties. A trust deed brings a third party into the mix. In the twenty states that mandate them, there is no other way to fund most real estate transactions. Note that there are a small handful of states that allow parties to choose between trust deeds and mortgages.
How a Mortgage Works
You are probably familiar with how a mortgage works. But if not, a mortgage is essentially a legally binding contract between lender and borrower. The lender agrees to loan so much money while the borrower agrees to repay the loan with interest. In the interim, there is a deed to worry about.
A mortgage scenario results in the deed of the acquired property being transferred into the name of the buyer. The lender places a lien on the property, usually in first position, in the event that the property has to be seized and sold due to default. Because the deed is actually transferred into the owner’s name, the owner retains all rights and privileges of ownership. Those rights and privileges are only lost in the event of foreclosure.
How a Trust Deed Works
A trust deed is an arrangement between three parties: lender, borrower, and a third-party trustee. Lending and borrowing remain pretty much the same. The difference is found in the deed. Upon sale of the property, the deed is transferred into the name of the trustee who then takes legal ownership of the property and holds it in trust on behalf of the buyer. Meanwhile, the buyer maintains all the rights and privileges of ownership.
The deed is held in trust until the loan is paid in full, at which time it is transferred into the buyer’s name. The transaction is done, and all parties go their separate ways. In the event of default, the trustee takes legal possession and auctions the property off. Sale proceeds then go to the lender.
Trust Deeds and Hard Money Loans
While most instances of trust deeds relate to residential properties and primary residences, they sometimes come up in commercial real estate transactions. For example, a hard money lender may or may not be willing to lend under a trust deed scenario. It depends on the lender, the project in question, and how state law governs the transaction.
It is possible to mix a hard money loan and trust deed in order to achieve certain property investment goals. For example, an investor looking to purchase a piece of vacant land to develop may obtain a hard money loan to acquire the land. According to Salt Lake City Utah’s Actium Partners, this type of transaction is pretty common.
Because the hard money lender doesn’t make improvement or construction loans, the investor has to obtain additional financing elsewhere. Private lending via a trust deed is a solution that allows the investor to repay the hard money loan and begin land development.
A hard money loan is generally a contract between two parties, much the same as a mortgage. A trust deed pulls in a third party by way of an independent trustee who holds legal ownership of the property until funding debts have been settled. That is it in a nutshell.
