Understanding the Differences in Property Contracts
When you start getting involved in the buying and selling of real estate notes, it can seem like there is a secret language, known only to buyers and lenders. “Mortgage” is simple enough, but once phrases like “deeds of trust” and “promissory note” start getting thrown around, the whole thing can start to seem like a confusing mess.
This is intensified when you realize that mortgage, deeds of trust, and promissory note all seem to mean the exact same thing. So why have three separate words in the first place?
These words are similar in meaning. But like with everything involved in note buying and selling, there is nuance here.
Keep reading and we’ll take you through the ins and outs of mortgages, deeds of trust, and promissory notes.
Catch the root word there. It’s from the Latin promissorious, and it means, surprise, “to promise”.
If you were asked to name the piece of paper you signed when you bought your home, you would probably be tempted to call it your “mortgage”. And while the phrase mortgage might be colloquially correct here, the technical term and the one you want to be familiar with is “promissory note”.
This is the piece of paper that contains the promise to pay back a debt. It will contain the debt terms, amount owed, interest rate, and the maturation date of the loan.
The important thing to remember here is that regardless of whether you have a mortgage or a deed of trust, you will certainly have a promissory note. It is used in conjunction with these other documents, not instead of.
This is the document you will issue if you seller finance a house, and it is the document a note buyer is interested in if you decided to sell your note.
Mortgage vs Deed of Trust
A mortgage and a Deed of Trust are essentially the same thing, with a few differences in terms of legality and rules.
Both provide the security for a loan, in this case taking the form of a home or other property. This gives the lender safety in knowing that if the loan defaults, they don’t lose their investment.
Whether you will have a mortgage or Deed of Trust depends on where you live, and controls how many parties are involved in the process, as well as the rules surrounding foreclosure.
Mortgages have become a bit of a blanket term for any home loan. After all, when you pay your bills, you say you are paying your “mortgage”, not your “Deed of Trust”, even if you do, indeed have a deed of trust.
A mortgage involves two parties: the lender and the borrower. The borrower makes a deal with the lender to pay the loan, issues a promissory note and a mortgage (instrument) as security.
A mortgage also has specific guidelines regarding what happens in the event of foreclosure.
In the case of a mortgage, foreclosure must go through the courts in a process known as “judicial foreclosure”. The lender must file a lawsuit, and the process can be costly and lengthy.
Deeds of Trust
Like a mortgage, a Deed of Trust functions as security instrument for the loan.
The difference here lies in foreclosure procedures as well as the number of people involved in the loan.
For a deed of trust, there are three parties at the table; the lender and borrower, of course, as well as a trustee. The role of the trustee is to start the foreclosure process in the event of default. Typically, this is not a single person, but an escrow company.
In a foreclosure on a deed of trust, proceedings take place out of court. They are governed by state laws and procedures, but typically take less time than judicial foreclosures and are less costly. Also, as mentioned above, a trustee initiates foreclosure, rather than the lender.
Will you have a mortgage or deed of trust?
The answer to this question is almost completely dependent on where you live. Most states only allow one or the other, but there are a few that allow both.
This is especially important to know if you are seller financing your property, as deeds of trust can be more favorable to smaller or individual lenders. Here is the processes, laws and turnaround time state by state.
Other than a few rules about parties and foreclosure, mortgages and deeds of trust offer the same function: security on a loan. Promissory notes are the agreements of the loan terms themselves. In any property buying or selling, you’ll have one of the former, and certainly the latter.