Trust Deed Basics
What is a Trust Deed?
A "trust deed" investment is where an investor makes or purchases a loan to a borrower which is evidenced by a promissory note and secured by a deed of trust (i.e. trust deed) encumbering real property. The deed of trust (also known as a mortgage in some states) is recorded in the county recorder's office where the real property is located and creates a lien on the borrower's property to secure the repayment of the borrower's debt obligations under the promissory note.
What is a promissory note?
Promissory notes are written promises to pay or repay certain amounts of money at a certain time, or in a certain number of installments to the holder of the note. Specified within the note:
- Amount of the loan (principal)
- Interest rate (interest)
- Amount and frequency of payments (debt service)
- When the borrower must repay the principal (maturity date)
- Penalties imposed if borrower does not repay per agreement
How do you obtain a promissory note?
You obtain a promissory note (i.e. become a lender or note holder) by either funding a loan at loan closing or purchasing an existing promissory note from the original lender. Investors purchasing trust deed investments prior to the funding of the loan will be named as the lender on the promissory note signed by the borrower. Investors purchasing trust deed investments following the initial loan funding will have the promissory note asssigned to them by the original lender that funded the loan.
What secures your investment?
Your investment is secured by the property identified in the deed oftrust. By recording a deed of trust naming the investor as thebeneficiary (or by recording an assignment of the recorded deed oftrust to the investor), the investor has a lien against title to theproperty which secures the repayment of all amounts payable to theinvestor under the promissory note. In the event the borrower fails tomake the payments to the investor under the promissory note, the deedof trust grants the investor the power to force the sale of theborrower's property and have the proceeds of the sale applied to theunpaid amounts due under the promissory note.
What is lien priority?
A deed of trust recorded prior in time to any other liens on the property is called a first trust deed and creates a lien on the property that is senior in priority to all subsequently filed (junior) deeds of trust filed against the property (i.e. second trust deeds, third trust deeds, etc.). Generally, if the investor holds a junior trust deed, the proceeds from the sale of the borrower's property will be used to pay off the amounts due under the first trust deed (and any other senior trust deeds) prior to the payment of any remaining sale proceeds to the junior trust deed holder.
Investments in trust deeds involve risk. Investors should review the materials entitled "Trust Deed Investments; What You Should Know" and "Summary of Risk Factors Related to Trust Deed Investments" provided in the Investor Tools Document Library prior to investing.