In the context of a real estate transaction, a deed of trust is a legal document declaring that a property will be held by a neutral third party until any loan is paid off.
What is a Deed of Trust?
A deed of trust, also sometimes known as a “trust deed,” is used in some states as an alternative to a mortgage. It’s a document that says the property (bought with a loan) will be held by a neutral third party—like a bank, or escrow company—until the loan can be paid off in full. This means that the legal title of the property temporarily belongs to the third party, known as the “trustee.” If the borrower stops paying the loan, the trustee takes control of the property.
A deed of trust is used in 20 states: Alaska, Arizona, California, Colorado, Idaho, Illinois, Mississippi, Missouri, Montana, North Carolina, Tennessee, Texas, Virginia, and West Virginia.
A few states—such as Kentucky, Maryland, and South Dakota— allow either one.
Deed of Trust VS. a mortgage
A deed of trust sounds pretty similar to a mortgage, and they’re both used by banks for real estate transactions, so what’s the difference?
A deed of trust is a contract in which three parties are involved: the borrower, the lender, and a third party or trustee. The third-party trustee has to be impartial because they’ll need to sell the property in case the borrower can’t pay off their loan. In this case, it’s crucial the third party be neutral so they don’t try to change the price to benefit either party.
A mortgage, on the other hand, is an agreement between only two parties, the borrower (aka a mortgagor) and the lender (mortgagee).
Another difference between the two is that with a deed of trust, the lender doesn’t have to go through the court system to sell the home, if it comes to that.
If the borrower doesn’t come through on monthly payments (four to be exact), the third party or trustee can sell it at a private auction, so it’s more attractive for smaller, non-traditional lenders. When the borrower can’t come through on payments with a traditional mortgage, the foreclosure and selling of the property must go through the courts.