A Deed of Trust is a legal document used in real estate transactions that serves as a security instrument for a loan. It is commonly used in states that do not use mortgage loans. The deed of trust is a three-party agreement between the borrower (also known as the trustor), the lender (also known as the beneficiary), and a neutral third party known as the trustee.
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The purpose of a deeds of trust is to provide security for the lender by granting them a lien on the property being financed. This lien allows the lender to foreclose on the property in the event that the borrower defaults on the loan. The deeds of trust is recorded in the county where the property is located, providing public notice of the lender’s interest in the property.
States that Use a Deed of Trust
A Deed of Trust is commonly used in many states across the United States. However, it’s important to note that not all states use deeds of trust. In some states instead of a deeds of trust, a mortgage is used or both can be used. Learn. Learn about what a Mortgage is and Mortgage vs Deed of Trust.
The states that primarily use a Deed of Trust include:
- Alaska
- California
- Colorado
- District of Columbia
- Georgia
- Hawaii
- Idaho
- Maine
- Massachusetts
- Minnesota
- Mississippi
- Missouri
- Nebraska
- Nevada
- New Hampshire
- New Mexico
- North Carolina
- Oregon
- Rhode Island
- Tennessee
- Texas
- Utah
- Virginia
- Washington
- West Virginia
- Wyoming
These states have adopted the use of a deeds of trust as the primary method of securing real estate loans. However, it’s important to consult with a local attorney or real estate professional to understand the specific laws and practices in your state.
What Documents are Required for a Deed of Trust?
- Deed of Trust: The primary document that outlines the terms of the trust agreement and secures the loan with the property. The deed of trust is almost always recorded in the county courthouse. It is signed by the borrowers in front of a notary but is not always witnessed. It also bears a notary seal.
- Promissory Note: A document detailing the terms of the loan, including the amount borrowed, interest rate, repayment schedule, and borrower’s promise to repay. It is usually not recorded, although it can be. The promissory note is not typically witnessed but must be signed by the borrowers.
- Trustee Appointment: A document appointing the trustee who will hold legal title to the property until the loan is satisfied. The trustee appointment document for a deed of trust is typically notarized but is not always witnessed. This document appoints the trustee who will hold legal title to the property until the loan is satisfied. The trustee appointment is an essential part of the deed of trust process but is not usually recorded in public records.
- Assignment of Rents Agreement (Optional): In addition to the Deed of Trust document and promissory note, there can also be an assignment of rents agreement, which states that if the borrower stops making payments, the lender has the right to collect the rent and apply it towards the outstanding debt.
Typical Features and Clauses
A Deed of Trust typically includes the following key features:
- Identification of Parties: The Deed of Trust identifies the borrower (trustor), lender (beneficiary), and trustee. It includes their names, addresses, and other relevant contact information.
- Description of Property: The Deed of Trust includes a detailed description of the property being financed, including its legal description, address, and any other relevant details.
- Loan Terms: The Deed of Trust outlines the terms of the loan, including the principal amount, interest rate, repayment schedule, and any other relevant terms and conditions.
- Security Interest: The Deed of Trust grants the lender a security interest in the property being financed. This allows the lender to foreclose on the property in the event of default.
- Power of Sale: In some states, the Deed of Trust includes a power of sale provision, which allows the trustee to sell the property without going through a lengthy foreclosure process.
- Default and Remedies: The Deed of Trust specifies the events that constitute default and outlines the remedies available to the lender in the event of default, including foreclosure.
- Release of Deed of Trust: Once the loan is fully repaid, the Deed of Trust is typically released by the lender, providing clear title to the borrower.
Types of Deed of Trust Loans
There are several different types of Deed of Trust loans available. The most common types include:
1. Fixed-Rate Deed of Trust Loan
A fixed-rate deed of trust is a type of deed of trust where the interest rate remains the same throughout the entire duration of the loan. This means that the borrower’s monthly payments will also remain constant, providing stability and predictability. Fixed-rate deeds of trust are popular among homeowners who prefer a consistent payment amount and want to avoid the risk of rising interest rates.
2. Adjustable-Rate Deed of Trust Loan (ARDTL)
An adjustable-rate deed of trust, also known as an ARDTL, is a type of deed of trust where the interest rate is variable and can change over time. Typically, the interest rate is fixed for an initial period (such as 5, 7, or 10 years) and then adjusts periodically based on market conditions. The initial interest rate is usually lower than that of a fixed-rate deed of trust, making it an attractive option for borrowers who plan to sell or refinance their home before the rate adjusts.
Two examples below illustrate how ARMs offer an initial fixed-rate period followed by adjustable rates, providing flexibility for borrowers who may anticipate changes in interest rates in the future:
- 5/1 ARM: In a 5/1 ARM, the initial interest rate remains fixed for the first five years of the loan term. After the initial fixed period, the interest rate adjusts annually based on a predetermined index and margin. For example, a 5/1 ARM might have an initial interest rate of 3.5% for the first five years, then adjust annually based on the index plus the margin.
- 7/1 ARM: A 7/1 ARM works similarly to a 5/1 ARM, but the initial fixed-rate period lasts for seven years before the interest rate adjusts annually. For instance, a 7/1 ARM could start with a fixed rate of 4% for the first seven years, then switch to yearly adjustments based on market conditions.
3. Government-Backed Deed of Trust Loan
Government-backed deed of trust loans are loans that are insured or guaranteed by a government agency. These types of mortgages often have more flexible qualification requirements and lower down payment options.
- FHA loans have low down payment requirement of just 3.5% (depending on credit score), making homeownership more accessible for buyers who may struggle to save a traditional 20% down payment. These loans also have more lenient approval criteria, allowing individuals with past bankruptcies to qualify for financing.
- USDA loans are specifically designed for homebuyers looking to purchase property in designated rural areas as defined by the USDA. These fixed-rate loans often offer the benefit of zero down payment, making them an attractive option for buyers in rural communities.
- VA loans, exclusively available to military service members, retired service members, and certain surviving spouses, offer up to 100% financing, eliminating the need for a down payment. This benefit makes homeownership more achievable for those who have served in the military.
4. Jumbo Deed of Trust Loan
Jumbo deeds of trust are non-confirming loans and are a type of deed of trust that exceeds the loan limits set by government-sponsored enterprises like Fannie Mae and Freddie Mac. These loans are typically used to finance high-value properties or properties in expensive real estate markets. Jumbo Deeds of Trust often have stricter qualification criteria and higher interest rates compared to a conventional deed of trust.
5. Interest-Only Deed of Trust Loan
An interest-only deed of trust is a type of deed of trust where the borrower is only required to make interest payments for a certain period, typically between 5 and 10 years. After the interest-only period ends, the borrower must start making principal and interest payments. Interest-only deed of trust can provide lower initial monthly payments, but they can also be riskier as the borrower does not build equity during the interest-only period.
6. Balloon Deed of Trust
Some deeds of trust include a balloon payment. A balloon payment is a lump sum payment made by the borrower, typically for the remaining outstanding balance at the end of the agreed term. A deed of trust can be interest-only, with the entire principal due at the end of the term, or it can be amortized over a long period, such as 30 years, with the entire outstanding balance due in, for example, 5 years.
7. Reverse Deed of Trust Loan
A reverse deed of trust loan, is a financial product that allows homeowners aged 62 and older to convert a portion of their home equity into cash. Unlike traditional deed of trust loans, with a reverse deed of trust loan, the lender makes payments to the borrower, either as a lump sum, a line of credit, or monthly installments. The loan balance increases over time as interest accrues and is typically repaid when the borrower sells the home, moves out, or passes away. Reverse Deed of Trust loans can provide older homeowners with financial flexibility and supplement their retirement income.
Key Components of the Loan
A deed of trust consists of several key components that both the borrower and the lender need to understand, including:
1. Principal
The principal is the initial amount of money borrowed by the borrower to purchase the property. It represents the actual cost of the property and does not include any interest or fees. The borrower is required to repay the principal amount over the term of the deed of trust.
2. Interest
Interest is the cost of borrowing money from the lender. It is calculated as a percentage of the outstanding loan balance and is added to the borrower’s monthly deed of trust payment. The interest rate can be fixed or adjustable, depending on the type of deed of trust chosen.
3. Loan Term
The loan term refers to the length of time the borrower has to repay the deed of trust in full. Common loan terms for deeds of trust are 15 years, 20 years, or 30 years. The longer the loan term, the lower the monthly payments, but the more interest the borrower will pay over the life of the loan.
4. Down Payment
A down payment is a lump sum payment made by the borrower towards the purchase price of the property. It is typically expressed as a percentage of the property’s value. The down payment amount can vary depending on the type of deed of trust and the lender’s requirements. A higher down payment often leads to better loan terms and lower monthly payments.
5. Closing Costs
Closing costs are fees and expenses associated with finalizing the deed of trust loan. These costs can include appraisal fees, title insurance, attorney fees, and loan origination fees. Closing costs are typically paid by the borrower and can be a significant expense in addition to the down payment.
6. Lender’s Title insurance (LTI) or Lender’s Mortgage Insurance (LMI)
Deeds of trust do not have private mortgage insurance (PMI) as mortgages do. Instead, deeds of trust may have a similar form of insurance called Lender’s Title Insurance or Lender’s Mortgage Insurance (LMI), depending on the state. Lender’s Mortgage Insurance or Lender’s Title Insurance protects the lender in case the borrower defaults on the loan. It does not provide any protection or benefit to the borrower. LTI or LMI is typically required when the borrower’s down payment is less than 20% of the property’s value. The cost of LTI or LMI is usually added to the borrower’s monthly loan payments.
7. Escrow Account
An escrow account is a separate account set up by the lender to hold funds for property taxes and homeowners insurance. Each month, a portion of the borrower’s loan payment is deposited into the escrow account, and the lender uses these funds to pay the property taxes and insurance premiums on behalf of the borrower.
Foreclosing a Deed of Trust
In a mortgage, if the borrower defaults on the loan, the lender must go through a non-judicial foreclosure process, involving the court system.
Further Reading on Foreclosure:
- Foreclosure: What Private Lenders and Hard Money Lenders Need to Know
- Expert Guide to the Judicial Foreclosure Process
- What you need to know to Evaluate Foreclosure Losses
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