Why do lenders prefer deed of trust?

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Buying property usually comes with an avalanche of paperwork. It can be a confusing process, especially when it comes to knowing the difference between all the various documents you have to sign. If there’s one contract that’s important to understand, however, it’s the deed of trust.

Depending on your lender and the state you live in, you may or may not need a deed of trust when financing a home purchase. Here’s what you should know about this contract and how it differs from a mortgage.

What Is a Deed Of Trust?

When you finance the purchase of a property, you will sign either a mortgage or deed of trust—but not both. You can take out a mortgage in all 50 U.S. states, while a deed of trust is only available in some states.

A deed of trust is a legal document that secures a real estate transaction. It works similarly to a mortgage, though it’s not quite the same thing. Essentially, it states that a designated third party holds legal title to your property until you’ve paid it off according to the terms of your loan. Deeds of trust are recorded in public records just like a mortgage.

How a Deed of Trust Works

A deed of trust exists so that the lender has some recourse if you don’t pay your loan as agreed. There are three parties involved in a deed of trust: the trustor, the beneficiary and the trustee.

The three parties involved in a deed of trust for a real estate transaction are a:

  • Trustor. This is the person whose assets are being held in the trust, also known as the borrower (i.e., you). The title to your home is held by the trust until the loan is paid off. Even so, you remain the equitable owner as long as you keep paying the loan according to the terms outlined in the deed of trust. That means you enjoy all the benefits of being the homeowner, such as the right to live there and gain equity, even though you aren’t the legal title holder.
  • Beneficiary. The beneficiary is the party whose investment interest is being protected. Usually, that’s the lender, though it also can be an individual with whom you have a contract.
  • Trustee. The trustee holds the legal title of the property while you’re making payments on the loan. Trustees often are title companies, but not always. Once you’ve paid off your loan, the trustee is responsible for dissolving the trust and transferring the title to you.

If you sell the property before it’s paid off, the trustee will use proceeds of the sale to pay the lender the remaining balance (you keep the profits). If you fail to meet your payment obligations and default on the mortgage, the property would go into foreclosure, and the trustee would be responsible for selling the property.

What Is Included in a Deed of Trust

A deed of trust includes many important details about your property, loan and related terms and conditions—much of the same information you would find in your mortgage. Typically, you’ll find the following outlined in a deed of trust:

  • The names of the parties involved (the trustee, trustor and beneficiary)
  • The original loan amount and repayment terms
  • A legal description of the property
  • The inception and maturity dates of the loan
  • Fees
  • Various clauses, such as acceleration and alienation clauses
  • Any riders regarding the clauses outlined

It’s common for a deed of trust to include acceleration and alienation clauses. If you’re delinquent on your loan, it can trigger the acceleration clause—essentially a demand for immediate repayment of the loan. Depending on the terms, this can happen after missing just one payment, though lenders often give a few months of leeway to allow the borrower to catch up on payments. If you fail to do so under the terms outlined in the acceleration clause, the next step is formal foreclosure proceedings.

An alienation clause is also known as a due-on-sale clause and it prevents anyone who buys the property to take on the loan under its current terms. Instead, the alienation clause would dictate that the loan must be paid in full if you sell the property.

Depending on your state, the deed of trust may also include a power of sales clause. This allows for a much faster foreclosure process than if your lender had to involve the state courts in a judicial foreclosure.
That said, you won’t be foreclosed on overnight under a power of sales clause; the exact process differs by state and lender. Still, if you’re facing a nonjudicial foreclosure, it can happen in a matter of months. If you want to formally fight the foreclosure, you’ll need to hire a lawyer.

States that allow power of sale foreclosures include: Alabama, Alaska, Arizona, Arkansas, California, Colorado, District of Columbia, Georgia, Hawaii, Idaho, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Hampshire, North Carolina, Oregon, Rhode Island, South Dakota, Tennessee, Texas, Utah, Washington, West Virginia and Wyoming.

Deed of Trust Vs. Mortgage

The terms “deed of trust” and “mortgage” are often used interchangeably, but they’re really two different things. That said, there are also some similarities. To review, here are the key ways a mortgage and deed of trust are similar as well as different.

Similarities

  • Public record: Both documents are recorded with the county clerk.
  • Subject to state law: The exact terms of a mortgage or a deed of trust depend on the local state law.
  • Contracts, not loans: Neither document serves as the actual loan agreement; a deed of trust or mortgage is a contract that places a lien on your property and dictates how your lender can repossess the property through foreclosure.

Differences

  • Parties involved: A mortgage is an agreement between a borrower and lender, while a deed of trust involves a trustor, beneficiary and trustee.
  • Foreclosure type: A mortgage requires a judicial foreclosure, while a deed of trust allows for a nonjudicial foreclosure.
  • Foreclosure timeline: Judicial foreclosure on a mortgage can be a lengthy process, while nonjudicial foreclosure through a deed of trust is much faster.

Warranty Deed Vs Deed of Trust

Both a warranty deed and deed of trust are used to transfer the title of a property from one person to another. However, the difference between these two contracts is who is protected. As you now know, a deed of trust protects the beneficiary (lender). A warranty deed, on the other hand, protects the property owner.

When a property title is transferred with a warranty deed, ownership goes from the seller (also known as the grantor) to the buyer (also known as the grantee). The warranty deed guarantees that the previous owners, or grantor, had full ownership of the property and right to transfer it. In other words, it promises that you won’t inherit any liens or future claims against the property. It provides peace of mind that you own the property outright once the title is in your name.

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Why is it important to a lender to have both a deed of trust and a promissory note in California?

The promissory note is the promise to repay the loan funds to the lender. The deed of trust secures the house and land to the note and allows a lender to foreclose on a property if there is default. The most common default is failure to make the payments under the promissory note.

Which of these is a reason that the deed of trust is the standard security instrument used in California real estate transactions?

Which of these is a reason that the deed of trust is the standard security instrument used in California real estate transactions? California's foreclosure law makes the deed of trust the preferred instrument because it gives the lender the right to use a non-judicial foreclosure.