Mortgage or Deed of Trust?

When real estate purchasers apply for a loan, they call it a mortgage. In about 35 of the states, a mortgage is what they will sign at closing. However, in the remaining 15 states, the purchaser, instead, will sign a deed of trust or a deed to secure debt.

Although mortgages, deeds of trust, and deeds to secure debt all result in the real estate being collateral for loan, they are not the same. The difference between mortgages and deeds of trust (called deed to secure debt in some place) is based upon two different legal theories: the lien theory and the ownership/title theory.

Lien Theory vs. Ownership or Title Theory

Lien theory states are the most common. They use mortgages. A lien is an encumbrance on the real estate. The purchaser keeps title to the real estate. However, the real estate owner gives the lender a security interest in the real estate as collateral for the mortgage loan.

Ownership or title theory states use deeds of trust or deeds to secure debt. In those states, the purchaser does not keep title to the real estate. Instead, the purchaser transfers ownership to a lender or more commonly, a trustee.

The deed of trust will allow the borrower to use the real estate as long as the debt payments are made. When the borrower has paid off the loan, title to the real estate goes back to the borrower. However, if the borrower defaults, then the trustee is given permission to take possession of the real estate.

Despite these theoretical differences, from the borrower’s perspective, a mortgage and deed of trust may appear the same. In both a mortgage and deed of trust, if the borrower makes timely payments on the loan, the borrower will be able to use the real estate. And, with both a mortgage and deed of trust, when the debt is paid off, the borrower will own the real estate free and clear.

Foreclosure of a Mortgage or Deed of Trust

The difference between a deed of trust and a mortgage is noticeable when required loan payments are not made. The foreclosure process for a deed of trust is different.

With a traditional mortgage, the lender must file a court case, called a judicial foreclosure. The lender first will obtain a court order fixing the amount due under the loan. Then, the court will order sale of the real estate, usually at public auction under court supervision. The court then will order distribution of the proceeds from the sale.

Deeds of trust include authorization for the trustee to sell the real estate if payments are not made. The trustee, then, usually is responsible for selling the real estate and distributing the proceeds. Since the trustee technically owns the real estate, the trustee can deliver a deed transferring ownership of the real estate.  In some states, however, a court must confirm a sale under a deed of trust to be sure that it was conducted appropriately.

Power of Sale Clauses

In addition to a traditional mortgage, some states allow for mortgages to contain a power of sale. A mortgage with a power-of-sale clause might be considered a hybrid between a mortgage and deed of trust. A power-of-sale clause allows the lender to sell the real estate without going through the judicial foreclosure process if the borrower does not make required loan payments.

If a mortgage contains a power to sell, then if the borrower does not make required loan payments, the lender will usually arrange for and supervise a sale of the real estate. Since lien theory states which use mortgages consider the borrower to own the real estate, when a mortgage contains a power to sell, the lender will be required to obtain a court order confirming the sale. The court order not only confirms that the sale was properly conducted but also confirms that title has been properly transferred to clear up any title questions resulting from the fact that the previous title owner was the borrower.

The Lender Selects the Security Instrument

It is said that the party “who has the gold make the rules.” Deeds of trust and mortgages with power of sale clauses make it easier for lenders to sell the real estate if the borrower does not make loan payments. Therefore, if state law allows either a deed of trust or power of sale causes, lenders usually will require them as a condition to making the loan.

Borrowers may not be able to choose whether to sign a deed of trust or to agree to a power-of-sale clause. However, borrowers should read their loan documents, including the mortgage or deed of trust. Borrowers also should work with an experienced real estate attorney so that they understand their rights and obligations.