Deed of Trust Explained: How Does a Deed of Trust Work?

A deed of trust is a legal document that accompanies some home loans and signifies an agreement between a trustor (borrower), a beneficiary (lender), and a trustee (a third party). It temporarily grants the property's legal title to a trustee and guarantees that if the borrower defaults on the loan and the property enters foreclosure, the trustee holds power of sale and can order the property sold to pay off the lender.

A deed of trust functions as a security instrument for the lender because it promises collateral on their loan until repayment is complete. In the event of default, the foreclosure process begins and the property can be sold to recoup the cost of the un-repaid loan.

Understanding the legal significance of a deed of trust and learning how it works can demystify the home loan process.

• Escrow: The process varies by state, but deeds of trust typically originate during the escrow process of a real estate transaction. While the property is in escrow, a homebuyer negotiates a home loan with a lender who will present the borrower with a promissory note.
• Promissory note: The promissory note confirms that the buyer has rightfully purchased real property (proven with a warranty deed) and that they will fully repay the loan within a set amount of time. The promissory note also denotes the interest rate charged by the lender. The deed of trust accompanies the promissory note and serves as a formal lien on the property. The deed will contain a legal description of the property and grant legal title to a trustee (typically a title company) until the loan is repaid in full.
• Guarantees: The lender will want assurance from a title company that the property is free of previous liens or other encumbrances. They will also want the homeowner to purchase title insurance to protect the real property in the event of future third-party claims.
• Power of sale clause: The deed of trust will contain a "power of sale clause" that gives the trustee the right to sell the property if the trustor defaults on the loan. In such a scenario, the beneficiary (the lender) would initiate foreclosure proceedings, the property would be sold, and the proceeds would go toward repaying the beneficiary and covering attorney's fees.
• Public record: Deeds of trust and promissory notes must be signed in the presence of a notary public. Under most state laws, they must be formally filed at a county recorder's office.
• Reconveyance: When the borrower completely pays off the loan, the legal title transfers from the trustee to the homeowner. The promissory note is marked "paid in full" and the lender issues a reconveyance deed affirming that the loan contract has been fulfilled.

A deed of trust and a mortgage loan are security interests that serve very similar purposes and share many functions. The terms are sometimes used interchangeably; however, these legal documents differ in a few key ways.

• Number of parties: A deed of trust features three legal parties—a beneficiary (the lender), a trustor (the borrower), and a trustee (a third party who holds the legal title during the course of a loan). A mortgage only features two legal parties—a mortgagor (the borrower) and the mortgagee (the lender).
• Legal title: In a mortgage, both the lender and borrower share the legal title until a loan is paid off. In a deed of trust, a trustee holds the legal title.
• Types of foreclosure: If a borrower stops paying back a loan, the lender issues a notice of default and can pursue foreclosure. Mortgages are subject to judicial foreclosure via the court system. Deeds of trust are subject to nonjudicial foreclosure. A lender may prefer to use non-judicial foreclosure because it's faster and less expensive than judicial foreclosure. Also, buyers have no right of redemption in non-judicial foreclosure, which means they cannot buy the property back after the foreclosure sale.
• Availability: Real property mortgages are offered in all fifty states. Not all states offer deeds of trust as a legal instrument.

If your state offers both mortgages and deeds of trust, consult with a real estate law firm for personalized advice to determine which one best suits your needs.

All investments, including real estate investments, come with inherent risks which may involve the depreciation of assets, financial losses, or legal ramifications. The information presented in this article is for educational, informational, and referential purposes only. Consult a licensed real estate or financial professional before making any legal or financial commitments.

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