If you’ve been through the process of applying for a mortgage, you know there’s a lot of paperwork involved, and one of those pieces of paperwork includes a deed of trust or a mortgage.
Before you sign one of these documents, you may be wondering, “What’s the difference between a deed of trust and a mortgage?”
In this blog, we’ll review the definitions of both as well as their similarities and differences so that you can get a clear picture of how they relate.
Let’s get started.
1. What is a deed of trust?
In some states, a deed of trust will be used instead of a mortgage when a purchaser buys a property using borrowed funds.
A deed of trust is an agreement between a home buyer and a lender executed at the closing of a real estate transaction.
This document indicates that the home buyer will repay the loan and the mortgage lender will hold the legal title to the property until the loan is fully paid.
Here’s how a deed of trust works.
In exchange for a loan, the borrower provides the lender one or more promissory notes.
A promissory note is a document that states a promise to pay the debt.
It is signed by the borrower and contains the terms of the loan, including information like the interest rate and other obligations.
In addition, the borrower will transfer legal title to a neutral third party who holds title on the lender’s benefit as collateral for the loan.
This is done through a deed of trust.
When the loan is completely paid, the promissory note is marked “paid in full,” and a deed of reconveyance will be recorded returning legal title to the borrower.
The lender keeps the promissory note while the buyer is paying off the home.
The buyer keeps a copy only for their records.
2. What is a mortgage?
A mortgage is an agreement between a borrower and a lender that gives the lender the right to take the property if you fail to repay the money you’ve borrowed plus interest.
Mortgage loans are used to buy a home and to borrow money against the value of a home you already own.
As with a deed of trust, you will sign a promissory note at the closing (sometimes called a mortgage note), but the note will be secured with a mortgage deed rather than a deed of trust.
The key difference is that the mortgage deed does not transfer legal title to the lender, but instead places a lien on the property.
This lien allows the lender to take the property if you default on the loan.
When you have paid off the mortgage, a release of mortgage is recorded clearing the mortgage lien from the property.
3. What is included in a promissory note?
A promissory note will usually include the following terms:
The size of the loan
The down payment
The interest rate and any associated points
Whether payments are monthly or bimonthly
The type of interest rate and whether it can change (fixed or adjustable)
The loan term (i.e., how long you have to repay the loan)
Whether the loan has other features (i.e., prepayment penalty, balloon clause, an interest-only feature, or negative amortization)
3. What are the similarities between a deed of trust and a mortgage?
Mortgages and deeds of trust share some similarities, which is why some people confuse them.
Here are some of the similarities.
Neither a deed of trust nor a mortgage is a loan
Neither of these is the same as a home loan.
A loan is something that you agree to pay back to your lender.
Instead, both are contracts that place a lien on your property.
Both a deed of trust and a mortgage provide a way for a lender to repossess a home through foreclosure
Both serve the same basic purpose.
They state that, if you don’t follow the terms of your loan, then your lender can put your home into foreclosure.
While the type of foreclosure can vary, the mechanism used is still the same.
Both deeds of trust and mortgages are dictated by state laws
Both are still subject to state laws, meaning that your lender is dependent on what is legal in your specific state.
Not all states allow deeds of trust, and few states allow both.
However, some (like Alabama and Michigan) do.
If you live in a state that allows both, then it’s ultimately up to your lender to decide which type you’ll receive.
4. What are the differences between a deed of trust and a mortgage?
Due to the similarities, it’s easy for homeowners to confuse mortgages and deeds of trust.
After all, if some states use them in place of each other, wouldn’t they be nearly interchangeable?
Not exactly.
Mortgages and deeds of trust may serve the same purpose, but there are a few key distinctions that you should keep in mind.
Here are the top three:
Foreclosure type
The type of foreclosure depends on whether you have a deed of trust or a mortgage.
If you have a deed of trust, you’ll typically face a nonjudicial foreclosure.
On the other hand, for a mortgage, the lender will need to go through the courts.
Foreclosure length and expense
When you have a mortgage, your lender will need to seek a judicial foreclosure to take back your property.
This means that the mortgage will take more time and money to foreclosure on.
As a result, many mortgage lenders will use a deed of trust (if the state allows it) to prompt a nonjudicial foreclosure.
If this is the case, then your lender will almost always spend less time and money reclaiming your property.
Number of parties involved in the foreclosure
The number of parties involved between both types of contracts also differs.
A mortgage involves just two parties: the borrower and the lender.
A deed of trust has a borrower, lender, and a “trustee.”
The trustee is a neutral third party that holds the title to a property until the loan is completely paid off.
This neutral third party is often an escrow company.
If you don’t repay your loan, then the escrow company’s attorney must begin the foreclosure process.
5. Who does a deed of trust involve?
Above, we highlighted that the deed of trust involves more parties than a mortgage.
Let’s walk through each of these parties and their roles.
The Trustor
This individual is the person whose assets are being put into the trust.
If it’s a real estate transaction, then it’s the borrower.
The official legal title to the property is held by the trustee on behalf of the beneficiary; however, as long as the borrower continues to meet the terms and conditions of the trust, then the borrower still holds equitable title.
Having equitable title means that you enjoy the benefits of property ownership without legally owning the property.
During this time, you’ll have the right to live there and gain equity in the property as you make payments or the value increases.
The Beneficiary
The beneficiary of the deed of trust is the person whose investment interest is being protected.
Often, this is the lender, but it could also be a person that you have a land contract with to eventually own a property outright.
The deed of trust serves as the lender’s guarantee that you’ll pay off the loan in exchange for lending the money for the property.
The Trustee
The trustee holds the legal title while the payments are being made.
They’re supposed to be impartial and not do anything that unduly benefits either party (trustor or beneficiary).
As noted above, the neutral third party that serves as the trustee is often a title company.
If the deed of trust process proceeds in the way that home loans typically do, then the trustee has one of the three duties listed below:
- If the trustor decides to sell the property before the loan is fully paid off, the trustee should pay the lender the proceeds of the sale to cover the remaining amount due on the loan. The excess will go to the trustor that sells the property.
- If the loan is fully paid off before the end of the term, then the trustee is the one who will dissolve the trust and transfer the legal title to the trustor.
- In a third scenario in which the borrower defaults on the terms of the trust, then the role of the trustee is to sell the property in order to help the beneficiary protect their investment.
6. What does a deed of trust include?
A deed of trust has several different components (some of which are like a mortgage).
These aspects function similarly to a traditional property deed.
Here’s a list of what you’ll see included in a deed of trust.
Initial loan amount
This amount is what the lender or other trust beneficiary gives the borrower so that they’re able to purchase the house.
The initial loan amount is the agreed-upon purchase price minus the down payment.
This is an important part of the deed of trust because it indicates the amount that must be paid off by the end of the loan term.
Once you’ve fulfilled the loan requirements, you can dissolve the trust.
Property description
A deed of trust always includes a detailed description of the property being purchased.
It also specifically describes what the trustor has the right to if the guidelines of repayment are followed by the borrower.
Length of the loan
The length of the loan describes the time frame in which the loan must be paid off.
This is also referred to as the loan term.
If you’re negotiating with a single person, then this may be a mutually agreed-upon term.
However, a traditional lender is more often to set the term somewhere between 8 and 30 years.
This will largely depend on the type of loan that you’re interested in, your financial goals, and what you’re able to afford.
Keep in mind that if you pay off your loan earlier, then you’ll save on interest.
Loan requirements
Lenders may impose certain requirements to give you a loan.
Some of these conditions may include occupying the property as your primary residence and paying mortgage insurance.
You may also want to take note of whether there’s a prepayment penalty.
If you’re able to pay off your mortgage early, then you’ll want to know if you’ll be charged a fee for doing so.
Power of sale clause
This clause defines the circumstances under which a trustee can sell the property for the beneficiary.
This often comes into play only if you default on the mortgage.
Generally, a deed of trust has a much quicker foreclosure process because it’s a nonjudicial foreclosure.
This means that there’s no need for courts to get involved, and this speeds up the process.
That said, you’ll want to make sure you know what your rights and responsibilities are under the power of sale section.
Acceleration and alienation clauses
Both the acceleration and alienation clauses have similar practical effects on loan borrowers.
However, they’re triggered for different reasons.
An acceleration clause takes effect after a borrower is behind on their payments.
It may kick in as soon as the borrower is behind with one payment, or it may be effective after several payments are missed.
Regardless, if the full loan isn’t paid within the amount of time specified in the acceleration notice, then the trustee will likely move forward with foreclosure proceedings.
An alienation clause is also referred to as a due-on-sale clause.
It voids certain contractual obligations to an asset if that asset is sold or if ownership is transferred to another entity.
It’s used if the person/lender you’re dealing with doesn’t want to have anyone who buys the property assume the loan under its current terms.
They would get around this by having an alienation clause in the deed of trust that states the loan must be paid in full when/if you sell the property.
This clause may also be triggered if you do something like put the property in an LLC.
7. How do transfers work with each document type?
Transferring a mortgage between banks and other entities are common.
When a mortgage transfer occurs, it will be documented and recorded in county records.
An “assignment of mortgage” is the document used to transfer a mortgage from one entity to another.
Deeds of trust can be transferred like mortgages.
This assignment is usually recorded in the county records as well.
These are also referred to as “assignments.”
8. How do you determine if you have a mortgage or a deed of trust?
To find out if you have a mortgage or a deed of trust, you can take any of the following steps:
Look at the documents you received when you closed escrow on your house
Contract your loan servicer
Go to your local land records office and pull up the recorded documents (sometimes these records are also available online)
9. Does the deed of trust or mortgage impact how you hold the title to your home?
Title can be split into two concepts: legal title and equitable title.
The legal title holder is the person who is technically considered the owner of the property.
On the other hand, the equitable title holder has consistent control over the land in question.
When you have a mortgage, you would hold both legal and equitable title to the property.
With a deed of trust, the legal title gets transferred to the trustee, which means they are the legal owner of the property.
As the homeowner, you would hold equitable title.
From a use perspective, you’re the owner and can live on the property or improve it, but the trustee would continue to hold the legal title in case there’s a foreclosure.
Final thoughts
In some scenarios (and depending on your state), you might see your home closing with a deed of trust instead of a mortgage.
A deed of trust often involves more people than a mortgage, it isn’t foreclosed through the judicial system, and it impacts the title legally.
This is something to consider if your state prefers deeds of trust over mortgages!
Additional Resources
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Disclaimer: we are not lawyers, accountants or financial advisors and the information in this article is for informational purposes only. This article is based on our own research and experience and we do our best to keep it accurate and up-to-date, but it may contain errors. Please be sure to consult a legal or financial professional before making any investment decisions.
Prior to starting Gokce Capital, Erika received a Bachelor of Architecture from the University of Southern California and a graduate degree in Urban Policy from Columbia University. She worked as both an architectural designer and engineer in New York before joining the New York City Department of Housing Preservation and Development.
Erika currently lives in the New York Metropolitan area with her spouse, daughter and cat. She is originally from Chicago and still considers herself a midwesterner at heart.
Erika also loves to read, write and travel (fun fact, she has visited all 50 states and more than 30 countries!). Her new book, Land Investing Mistakes: 11 True Stories You Need To Know Before Buying Land, is now available on Amazon.