What Is a Deed of Trust? How Does It Work?

Homeownership comes with a lot of paperwork. Unless you’re able to pay for real estate in full, you’ll need some financing. If you are buying a home and financing it with a mortgage lender, you'll need to sign closing documents, which include important items like a promissory note and either a mortgage or a deed of trust. The promissory note is what it sounds like, a written document that has your promise to pay back the amount you borrowed for that real estate. It’s the quintessential IOU. 

A mortgage and a deed of trust are both legal documents that create a lien on the real property, but they are structured differently. Also, deeds of trust are only available in some states. This article will explain what a deed of trust is, how it works, and how the foreclosure process works if you have a deed of trust versus a mortgage.

What Is a Deed of Trust?

Like a mortgage, a deed of trust is a written agreement that creates a lien on the property. This is a way of saying that the lender has a security interest in the home or that the real estate is collateral, and the lender can take that collateral if the borrower doesn’t pay their loan back. But a deed of trust is structured differently than a mortgage. 

In a deed of trust, the borrower has what’s called equitable title to the real estate or property. This means they have a right to own the property. Though they don’t yet have legal title to the property because they still owe money to a lender. The borrower gives legal title—the actual ownership—to a trustee, who holds it for a beneficiary. In this case, the lender. This arrangement serves as collateral on the promissory note to the home loan. 

Some states allow a deed of trust to be used, and some don’t. Some states allow either a mortgage or a deed of trust to be used. Deeds of trust can be used in the following states:

Alabama, Alaska, Arizona, Arkansas, California, Colorado, the District of Columbia (D.C.), Georgia, Hawaii, Idaho, Illinois, Kentucky, Maine, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, Missouri, Montana, Nebraska, Nevada, New Hampshire, New Mexico, North Carolina, Oregon, Rhode Island, South Dakota, Tennessee, Texas, Utah, Virginia, Washington, West Virginia, and Wyoming.

State laws vary and it may be more beneficial to have a mortgage than a deed of trust depending on the protections available to borrowers and homeowners in that particular state. You may want to do a bit more research before deciding what is best for you.

Is a Deed of Trust Different From a Mortgage?

Yes. A deed of trust is different from a mortgage in a few important ways. Most notably, a deed of trust includes three parties instead of two. Also, the foreclosure process is handled differently. With a deed of trust, if a borrower defaults or doesn’t make their loan payments for a specific period the trustee has what is called the power of sale. This means it can foreclose without going to the courts. The trustee can sell the property at their discretion when it is in the best interests of the beneficiary, the lender. This is called a nonjudicial foreclosure. 

To foreclose on a home with a mortgage, the lender has to go to the courts and go through what is called a judicial foreclosure process. The lender has to follow strict requirements and give certain notices in a judicial foreclosure sale while the trustee in a deed of trust doesn’t have to follow those stricter requirements and notices. Bypassing these protections and safeguards allows the trustee to sell the real estate more quickly, which ultimately gives the homeowner less time and fewer options to address their default.

How a Deed of Trust Works

A deed of trust works together with the promissory note or home loan. The three players involved in a deed of trust are:

1. The “trustor,” also known as the borrower

2. The “trustee,” typically a title company with the power of sale, legal title to the real property, and the ability to hold a nonjudicial foreclosure

3. The “beneficiary,” also known as the lender

Only the following two players are involved in a mortgage:

1. The borrower, who has an interest in the real property but also allows the lender to have a lien on the real property

2. The lender, who has a security interest in the real estate and can foreclose by either a judicial foreclosure or a nonjudicial foreclosure

The trustee holds the deed of trust on their home (the real property) until the deed is paid in full, while the borrower holds legal, equitable title to the real property, possesses the real property, and has the responsibility to maintain it. Once the loan is paid in its entirety, the trustee files a deed of reconveyance with the county clerk’s office to remove the deed of trust lien from the real property. 

A deed of trust contains a lot of information about the responsibilities and obligations of the parties. The trustee is a neutral, impartial administrator. The borrower and lender must follow the provisions of the deed of trust.

Obligations Under a Deed of Trust

A borrower is obligated to make payments following the payment schedule in the promissory note. A lender is obligated to accept those payments and accurately report the outstanding balance owed. A trustee is supposed to be neutral and impartial. The trustee is obligated to recoup as much of the outstanding loan balance in a real estate transfer as possible if the borrower fails to make their loan payments. The trustee is obligated to be fair and act quickly, responsibly, and in the best interests of the beneficiary (the lender) so that they are paid in full. 

The deed of trust typically includes the following information:

• The parties involved (the trustor, the trustee, and the beneficiary)

• The loan amount and maturity date

• Escrow account details

• The legal description or abstract of the real estate

• A power of sale clause

• Information about fees and penalties, such as late fees and prepayment penalties

• Provisions regarding the foreclosure process including notice of default if the borrower defaults

• What happens between the mortgagor and mortgagee if there is a subsequent mortgage (if it is allowed by state law)

What Can My Lender Do if I Don’t Pay?

If you don’t pay on the promissory note, your lender can move forward with a foreclosure. Your lender will also notify and remind the trustee of their obligations under the deed of trust. Your lender will likely demand payment from you, add fees and penalties as allowed under the deed of trust, but also encourage the trustee to initiate a trustee’s sale under the power of sale clause from the deed of trust. This allows them to bypass all the protections and safeguards that would be available to you under a normal foreclosure process. Your lender will start making collection calls, sending letters, and taking other actions against you. 

A lender is typically less willing to work with a borrower or to be flexible when there is a deed of trust. Remember, it is easier and cheaper for a lender to recoup its loan amount through a foreclosure sale under a deed of trust than a normal mortgage.

Foreclosure Sale Under a Deed of Trust

A foreclosure sale under a deed of trust—also called a trustee’s sale—is done without court involvement. This nonjudicial foreclosure process is used in most states that allow a deed of trust, and it benefits lenders. State laws vary so be sure to check with the county clerk to see what your state’s rules are. 

In a judicial foreclosure process, homeowners have many protections and safeguards. Unfortunately, in the many states that allow nonjudicial foreclosures, homeowners don’t have the same protections like notice periods, redemption periods, and other safeguards. This can make being late or missing your loan payments when you have a deed of trust even scarier for you as a homeowner and borrower.

Since there is no foreclosure lawsuit and no judge to oversee the sale of the home when there is a deed of trust in play, you must be even more vigilant and organized than you would be in a traditional mortgage relationship.

Let’s Summarize...

A deed of trust is a legal tool that may accompany your closing documents when you purchase your home. It’s important to understand that while a deed of trust is similar to a mortgage, there are some critical differences. These differences could significantly affect you and your family if you have financial hardship down the road. This is especially true when it comes to the foreclosure process.

Take your time, review your options thoroughly, and utilize the resources available to you. A deed of trust may be the only option you have in getting a home loan depending on your state law, but now you are a little bit more informed about the pros and cons of a deed of trust.