Deed of trust: What it means for buyers
If you’re on the hunt for a new house, you’ve no doubt thought a little bit about getting a mortgage. It is, after all, the most common way to finance a home purchase. But mortgages aren’t the only method by which property ownership is handled between a lender and a borrower. Depending on what state you live in, you might come across a deed of trust.
A deed of trust is a very different mechanism than a mortgage, so it’s important to know how one works before agreeing to those terms. With so much to consider when buying a house — securing a loan, sorting out contingencies and figuring out closing costs, to name just a few — it’s easy for some things to fall through the cracks. Don’t overlook the distinction between a traditional mortgage and a deed of trust, though, because the ramifications could be significant.
Let’s take a look at what a deed of trust is, how it stacks up against a mortgage and how it might impact your home ownership status.
What is a deed of trust?
A deed of trust is a legal document involving a lender, a borrower and a trustee that is sometimes used in place of a mortgage to manage the transfer of property ownership. Under this type of agreement, a third party — the trustee — retains the title of the property until the borrower has fully repaid the loan balance. Once that happens, the title passes to the homebuyer. If the borrower defaults on the home loan, however, the trustee may take full ownership of the property. Deeds of trust are only available in select areas of the country, so homebuyers may not encounter them at all when considering financing options.
How does a deed of trust work in practice?
At its core, a deed of trust is a three-party relationship, with the trustee acting as a neutral agent. Generally speaking, an attorney, law firm or title company will step in to fill the role of the trustee. Having said that, there are some instances where a trustee may have a personal relationship with the borrower, such as a spouse, but we’ll get into that later. In most transactions involving trust deeds, these legal documents are used in lieu of conventional mortgages by lenders when transferring property to borrowers.
Once you’ve closed on a house, rather than hold onto the property title yourself, you’ll instead hand it over to a trustee. When your home loan has been repaid, the trustee will pass the deed back to you. Although the trustee possesses some ownership interest in the property, they’re not legally obligated to make payments on the home loan. That responsibility rests squarely on the borrower’s shoulders.
Despite the fact that the trustee holds the legal title during the entirety of the home loan, the borrower can still gain equity in the property. If you use a deed of trust when buying a house, you’ll also be responsible for keeping the building in good shape and addressing any legal liabilities.
Why are deeds of trust used?
At first glance, bringing another party into the lending process seems like an unnecessary complication in what is already a pretty complex arrangement. But lenders have a good — if a bit self-serving — reason to use a deed of trust rather than a mortgage.
In short: It’s much easier to conduct a foreclosure and regain property with a trust deed. Deeds of trust are exclusively used in non-judicial states — that is, states where lenders aren’t required to go to court to foreclose on a house. If you default on your home loan, full ownership would pass to the trustee. They can then transfer the deed to the lender or sell the property and use the proceeds to repay the remainder of the loan. In terms of real estate transactions, that’s pretty straightforward. It’s not hard to see why lenders might find that scenario more appealing than a protracted foreclosure process with a mortgage.
Deed of trust vs. mortgage: How do they compare?
Mortgages and trust deeds share a similar purpose, it’s just the way they go about it that’s a little bit different. Let’s take a look at where the two diverge:
Deed of trust
Foreclosure could take months
Foreclosure could take years
Trustee retains property title
Borrower retains property title
Often used in non-judicial foreclosure states
Often used in judicial foreclosure state
Where are deeds of trust used?
We’ve noted that trust deeds are only used in place of traditional mortgages in non-judicial states. What does that include? These states use deeds of trust instead of mortgage agreements:
- New Hampshire
- New Mexico
- North Carolina
- Rhode Island
- West Virginia
You can also add the District of Columbia to that list. Some states — Arizona, Illinois and Michigan, to name a few — may use both mortgage agreements and deeds of trust, while others, like Florida and New York, don’t use deeds of trust at all.
When might homeowners use a deed of trust?
So far, we’ve discussed trust deeds from the vantage point of the lender. Based on the info we’ve provided, they’re wouldn’t seem to be much benefit to using a deed of trust instead of a mortgage given the possible foreclosure considerations. Yet, many people choose to create a deed of trust. Why is that?
In some cases, a deed of trust can help borrowers navigate tricky ownership issues involving family members. For instance, maybe you want to put your partner on the deed, but you’re not legally married. A deed of trust can sometimes present an easier way to do just that.
Another scenario to consider is if a couple wants to refinance their home loan, but one spouse has low or no credit. Naming that person as the trustee on a deed of trust is one way to retain ownership interest without letting a low credit score get in the way of refinancing at a better interest rate.
Once someone is named as a trustee, it can be difficult to remove them without their approval. Say that same married couple got a divorce down the road. The trustee would need to sign a legal document disclaiming their interest in the property before their spouse could retain full ownership of the house.
A deed of trust establishes a legal agreement between three parties — the borrower, the lender and a trustee — to dictate how ownership of real estate will be transferred following a sale. These lending vehicles differ from mortgages in some pretty key ways, so you’ll want to understand how they work before signing a loan agreement. Deeds of trust are used in states where nonjudicial foreclosures are permissible, and as such, you should be aware of what might happen if you were to default on your loan payments.
The mortgage process is undeniably complex and can seem pretty daunting even if you’ve bought a home in the past. Don’t hesitate to speak with a lending expert who can help answer any questions you have as you explore all of your home loan options.
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