Also known as a deed of trust, a trust deed is a document that represents an agreement regarding real estate property between a borrower, a lender, and a trustee. Simply stated, a trust deed investment is an investment in a private real estate loan by an individual or group of individuals.
The deed of trust is recorded as evidence of the debt to the lender. The deed of trust remains recorded until the borrower repays the loan to the lender according to the terms of their loan agreement and it is then released.
It’s common to mistake a deed of trust as an agreement between two parties, a borrower and a lender. In fact, a deed of trust is a three-party agreement where the borrower (the property owner) is named as the “Trustor,” the lender is referred to as the “Beneficiary,” and the independent third party that will reconvey the property when the loan is repaid is named as the “Trustee.”
Trust Deed vs. Mortgage
Many people also use mortgage and deed of trust interchangeably, but they aren’t the same. While the deed of trust is an agreement between three parties as noted above, a mortgage is an agreement between only two parties. The two parties consist of the mortgagor which is the borrower and typically a homeowner, and the mortgagee which is the lender, typically a bank.
Because a trust deed and a mortgage are considered security instruments and evidence of indebtedness, once executed they are recorded at a county or other municipal public records office. Recording the trust deed serves to provide notice to the public that the real estate property noted in the trust deed is pledged as a security for a loan. This helps to secure the trust deed investment.
The Promissory Note
In addition to a deed of trust, the borrower also signs a promissory note which is their promise or agreement to repay the loan according to the stipulated terms including principal and interest to be paid over a specified length of time.
If the borrower pays the debt as agreed, the trustee executes a deed of reconveyance. This means the deed of trust is reconveyed, the borrower’s lien is released, and the lender’s interest in the property is removed from public records. In simple terms, reconveyance is public evidence that the borrower has repaid their loan.
Lending Institutions vs. Private Lenders and Investors
Typically, when you think of a mortgage lender, you think of a credit union or big bank – e.g., Wells Fargo, Bank of America, or Citibank. Or you may think of a mortgage lender as being a large pseudo-government entity such as Fanny Mae or Freddie Mac. These traditional lenders provide what are known as conventional loans where borrowers must meet strict criteria to qualify for their loan programs.
The little-known reality is that private money lenders and investors provide alternative sources of financing to those big banks and other entities. Private lenders allow borrowers who may not otherwise qualify for conventional loans to obtain the funding they need. Private money lenders are private parties who have the capital to invest. They simply elect to invest their capital in real estate loan transactions, – i.e., trust deed investments – as the designated lender/beneficiary, instead of other investment vehicles such as the stock market, bonds, or mutual funds.
In the case of private lending and trust deed investments, real estate brokers and mortgage brokers, who are licensed and regulated by the Department of Real Estate, serve as intermediaries. They assist their clients with real property loan transactions and match appropriate lending opportunities to their private party investors who may be a good fit for the particular terms of the loan.
Who Are Private Lenders?
Private lenders are investors of all sorts. Individuals can invest in trust deeds, or a group of individual investors can form a securitized loan pool created specifically for investing in trust deeds or mortgages. Securitized loan pools can consist of individuals, limited liability companies, family trusts, self-directed IRAs, or 401K retirement plans.
When a private party invests, they become the designated beneficiary on the deed of trust. When a securitized loan pool is a beneficiary, each investor purchases shares in a limited liability company (LLC) whose sole purpose is to fund loans with the pooled capital from the LLC’s individual investor members.
Matching Investors with Available Loan Transactions
Mortgage brokers are constantly involved in the ongoing process of matching trust deed investors with available, viable real estate transactions that require private funding. When a match is made, private lender investors have the choice of investing in and funding the entire trust deed or a fractional portion of the deed of trust.
When there are multiple investors, title to the property is held for each investor as tenants-in-common and each party’s percentage of interest in the subject property is spelled out so that the total percentage of interest in the property adds up to 100%. When the deed of trust is recorded, each fractional investor is listed and their percentage of interest becomes public record.
Part of the role of the mortgage broker is to advise their investor clients on how best to maximize their investment opportunity and minimize risk. Let’s look at the case of a private lender with one million to invest. While they could fund one large trust deed, it may make more sense to spread the risk and fund smaller portions of multiple trust deeds. This choice depends on a number of variables and the investor’s goals. But if the investor were to participate in five to ten trust deed investments, assuming an average monthly yield of 8 or 9 percent, they could see a monthly cash flow of approximately $6,600 to $7,500 while still mitigating risk.
Before any trust deed investment is made, mortgage brokers provide their investor clients with a material disclosure package that outlines the loan transaction, provides a summary of the proposed loan investment and includes all the back-up documentation: borrower application, borrower loan documents, borrower credit report, financials, preliminary title report, and other related investor disclosure documents. After reviewing this material disclosure package, the investor can make an informed decision about whether to invest in the trust deed opportunity or not.
After the Trust Deed is Signed …
Once the investor has decided to participate in a private lending scenario and all the loan documents are recorded, an investor can expect frequent and ongoing communication with their loan servicer with the mortgage broker.
The loan servicing broker collects payment from the borrower, processes interest payments, and forwards payment to the investor(s). The investor and the loan servicer will also be in communication about the disposition of any overdue payments.
This ongoing communication throughout the loan repayment process helps to forge positive relationships between the mortgage broker and trust deed investors. If the loan servicing relationship is problematic, the possibility of future investments is at risk. So it is after the deed of trust is recorded that the pressure is really on for the mortgage broker to be a great investing partner.
Founder, VP Investment Lending
Excel Trust Deed Investments
Sheldon founded Excel Trust Deed Investments (formerly Excel Financial) in 1986. Specializing in expedited and efficient loan closings, he applies creative problem-solving skills to every facet of the private lending process for his clients.
What Is a Deed of Trust? By Nina Semczuk, CEPF for smartasset.com June 25, 2018
Trust Deed Definition Reviewed by Troy Segal for Investopedia.com Updated March 22, 019