The Trust Deed
The Trust Deed
Trust deeds are the preferred security instrument of lenders. Trust deeds are also referred to frequently as a Deed of Trust. It should be noted that some states do not permit the use of a trust deed.
Two common misperceptions regarding a trust deed need to be addressed. First, although the word trust appears in the name of this security instrument, the trust deed does not create a trust. Second, although the word deed appears in the name of the trust deed, this security instrument is not a deed and does not grant or transfer title.
The parties to a trust deed are:
The trustor, also often referred to as the grantor, is the borrower.
The beneficiary is the lender. The lender is called the beneficiary because it benefits from the contract by earning interest on the loan. The beneficiary is the payee and holder of the promissory note.
The trustee is a disinterested third party given the authority to hold the trust deed. The trustee is authorized to hold this instruments until instructed by the beneficiary to take some action. The trustee is typically a title or escrow company, an active attorney, a bank or savings and loan association, or the United States Government or any of its agencies. The trustee and the beneficiary cannot be the same entity. Therefore, if a commercial bank makes a loan to a borrower, the bank cannot appoint itself as trustee.
Under a trust deed, the trustor has actual legal title to the property and the beneficiary has a security interest in the property by way of a lien. The trustee has what is sometimes referred to as naked legal title, which is only one of the rights of ownership - the power of sale in the event of trustor default. This means that the trustee has the power to sell the property for the benefit of the beneficiary in the event of trustor default.
The trustee will hold the trust deed until instructed by the beneficiary to do one of the following two actions:
Loan paid in full as agreed - When the trustor pays the loan in full as agreed, the beneficiary will cancel the deed of trust and direct the trustee to issue a deed of full reconveyance. The effect of the reconveyance deed is that the trustee gives up its naked legal title and conveys it back to the trustor. When the reconveyance deed is recorded in the county in which the property is located constructive notice is given that the trustor's debt has been satisfied, the beneficiary's encumbrance has been removed, and the trustor owns the property free and clear of the beneficiary's lien. The beneficiary has no further right to foreclosure.
Loan NOT paid in full as agreed - If the trustor does not pay off the loan as agreed, the trustee will be instructed by the beneficiary to sell the property. Since trustee has naked legal title during the time the trustor owes the beneficiary money, this gives the trustee the authority to sell the property upon the instruction of the beneficiary.
Under a trust deed, the beneficiary has two choices as to how to foreclose in the event of default. The first choice is judicial foreclosure, which is the method used to foreclose a mortgage. Under a judicial foreclosure, the defaulting trustor has the same redemption period as a defaulting mortgagor. In some states, the beneficiary can only get a deficiency judgment if the trust deed is a commercial trust deed or an investment property. If the trust deed is secured by the trustor's personal residence, no deficiency judgment is permitted when it is owner occupied or occupied by a member of the trustor's family. However, many states will allow a lender to seek a deficiency judgment after a trustees sale.
The second available method the beneficiary has to foreclose a trust deed without court action is by advertisement and sale by the trustee. This process is also referred to as nonjudicial foreclosure or foreclosure by trustee sale. If this option is elected, the trustee must follow the following procedures:
- Notification of Trustee - The beneficiary must notify the trustee that the trustor (the borrower) is in default and that the beneficiary (the lender) is directing the trustee (the disinterested third party) to commence a foreclosure sale.
- Notice of Default and Election to Sell - The trustee will record a Notice of Default (NOD) with the county clerk in the county in which the property is located. The notice must be filed within a time period specified by state law such as at least 120 days before the date the sale is to occur. The notice must also be published in a local general circulation newspaper once each week for four weeks prior to the sale date. The defaulting trustor must be served or mailed a copy of the notice.
- Trustor Right of Reinstatement - The trustor has a specified period (such as up to five days) before the date the sale is to take place to reinstate the loan. The loan can be reinstated by paying the loan delinquency amount, plus payment of any trustee's fees. The trustor has to pay only the loan delinquency; the loan does not have to be paid in full.
Sale of Property - If the defaulting trustor does not pay the delinquent balance, the property is sold at a trustee's sale. Anyone, including the defaulting trustor, the beneficiary, or third parties, can bid at the trustee's sale. The only party that cannot bid is the trustee. The beneficiary may be considered the high bidder in the event no other party bids high enough to cover the loan balance, the trustee's fees, and costs of sale. The high bidder at the trustee's sale will receive a judicial deed known as a Trustee's Deed. The trustor may retain possession of the sold property for a short time after the date of sale.
Most lenders (beneficiaries) foreclose a loan secured by a trust deed by the statutory procedure of trustee advertisement and sale. Clearly, the main advantage of this method is the ease of the process and the relatively short time required to foreclose. In addition, most state laws also cancel the right of the trustor (borrower) to cure a few days (such as five days) prior to the sale, the trustor has no further rights or recourse except the right to bid on their own property at the trustee's sale. In many states, there is no right of redemption period to wait out, though that will vary by state (e.g., Michigan does have nonjudicial redemption periods based on the amount owed and type of property foreclosed, whereas in Oregon there is no nonjudicial redemption period).
From the discussion above, it can be seen that most lenders elect to use a trust deed instead of a mortgage for the security instrument in states where it is permitted. Again, the ease of foreclosure, the typically short foreclosure period, and the (possible) lack of any rights of redemption time periods are clear advantages for the lender. The reason a lender might prefer to use a mortgage instead of a trust deed is the ability to obtain a deficiency judgment in the event the property sale proceeds are not sufficient to cover the remaining balance of the loan, along with the costs of the foreclosure process.