Foreclosure Laws: Deed of Trust vs. Mortgage Deed
To understand the home loan foreclosure process, we first need to understand the mortgage instrument. It may surprise most homeowners to learn that mortgage loans contain two distinct elements: the security instrument (mortgage deed or deed of trust) and the loan promissory note.
The promissory note is the borrower’s obligation to repay the loan. You don’t need a mortgage deed to create a loan. Practically all legal debts involve some type of promissory note.
To turn a debt into a mortgage loan, you need to combine the loan with a security instrument—such as a mortgage deed.
Whereas the promissory note is the borrower’s promise to repay the loan, the mortgage deed (or other security instrument) is the borrower’s agreement to put up the property as collateral for the loan.
When a loan is secured by real estate, it’s typically a mortgage loan. That real estate security is what makes the loan a mortgage loan. That real estate security is also what convinces lenders and investors to risk their money in lending it to homebuyers they’ve never met and against a future that may bring problems.
Although the lender does not receive title to the property, the mortgage instrument means that the borrower’s ownership will not be complete until the loan is paid off. There are two basic types of security instruments used in the United States:
- Mortgage deeds
- Deeds of trust
States that Use Mortgage Deeds
The mortgage deed is used in the majority of states. The mortgage deed places a lien on the subject property’s title. Unlike a car loan, for example, the property’s title remains fully in the borrower’s name.
But that mortgage lien recorded at the county recorder’s office against the property’s title is a powerful restraint on the borrower’s ownership of the property. The mortgage deed allows the property to be foreclosed and sold when the loan is in default. Most, though not all, mortgage foreclosures involving mortgage deeds require a judicial process.
Although some states allow for both mortgage deeds and deeds of trust, the following states rely primarily on mortgage deeds:
- New Jersey
- New Mexico
- New York
- North Dakota
- South Carolina
- South Dakota
With the exception of Hawaii, these mortgage deed states rely primarily on judicial foreclosures.
States that Use Deeds of Trust
Unlike the standard mortgage deed, the deed of trust takes the property’s title away from the borrower while there is still money owed on the mortgage loan. However, unlike a car loan, the deed of trust does not give the property’s title to the lender.
Instead, the deed of trust adds a third party (the trustee) between the lender and the borrower.
The deed of trust takes away the property’s title from borrower and puts it in a legal trust. The trustee, usually a trust company, is officially the owner of the property. But the trustee is severely restricted in what they can and must do with the property.
When the loan balance is paid in full, the trustee must convey the property’s title to the borrower before terminating the trust. However, if the loan is in default and property goes into foreclosure, the trustee will sell the property and use the proceeds to pay off the loan and other liens. The trustee is typically paid by the lender for its services, although the lender usually will pass the trustee’s fees to the borrower.
Note that the mortgage payments are paid directly to the mortgage lender or its servicer. No payments are made to the trustee. If the trustee receives mortgage-related correspondences, such as tax bills and legal notices, the trustee will forward them to the lender or borrower, as necessary.
Although some states allow for both mortgage deeds and deeds of trust, Washington, D.C. and the following states rely primarily on deeds of trusts:
- North Carolina
- West Virginia
Washington, D.C., and the above states rely primarily on non-judicial foreclosures.
Because there is no need to take the property’s title from the borrower, there is no need for a court hearing. The deed of trust is definitely more lender-friendly and less consumer-friendly than mortgage deeds, resulting in quicker foreclosures.
The Type of Mortgage Determines the Type of Foreclosure
As mentioned earlier, each state has its own set of laws governing foreclosure procedures in that state. However, the vast majority of mortgages fall into one of two categories:
- Judicial foreclosures
- Power-of-sale (non-judicial) foreclosures
In general, most real estate foreclosures involve the sale of the subject property. The proceeds are then used to pay off all liens and foreclosure-related expenses. If there are any surplus funds remaining after the sale of the property, those excess proceeds would go to the borrower who just lost his or her property.
Both of the above categories of foreclosures will be discussed and dissected in this and later chapters. Both methods require foreclosing lenders to follow specific guidelines and steps when they foreclose on a property.
Understanding the required procedures can help distressed homeowners delay and possibly redeem their properties from foreclosure.