An Intro to Trust Deeds
Trust deeds are the backbone of trust deed investing. Simply put, a trust deed is a loan secured by real estate. This legal document gives a real estate lender the right to foreclose and sell a property if the borrower falls behind on their mortgage payments.
In California (and many other states), trust deeds are the most common form of a real estate loan. Many refer to the trust deed as the modern-day version of the mortgage.
A trust deed is often referred to as though it were a singular loan and investment instrument, but in fact, a trust deed is the culminating result of two separate documents; the promissory note and the deed of trust.
The deed of trust transfers ownership of the security to a trustee. The promissory note represents the borrower’s obligation to pay.
These two elements stand alone pending the creation of the other. When cross-referenced to each other they become a loan secured by real estate (a trust deed).
Who are the Parties to a Trust Deed
When creating a trust deed, one major advantage gained over other forms of real estate lending and investing is the existence of the trustee. The loan’s security is assigned to a third party trustee, who takes limited title of the property, and who is charged with arbitrating the agreement between the borrower (trustor) and the lender (beneficiary).
What is a first trust deed?
When investing in trust deeds your claim to the property is publicly recognized when the deed of trust is recorded in the county where the property is located.
The recorded document with the borrower’s notarized signature then remains an encumbrance on the property until the loan is paid.
The chronological order in which deeds of trust are recorded determines the priority of their claim over other instruments.
A first trust deed is a mortgage that has priority over all other mortgages or trust deeds. This simply means that the first trust deed was recorded before any other liens, encumbrances or trust deeds involving your property.
Priority is important because if a borrower defaults, the parties in the first trust deed position will be the first to be paid back their money once the property is sold out of foreclosure.
What is the trust deed investment opportunity?
If a business requires capital quickly, streamlined processes allow debt funds to meet their needs faster than a traditional lender. This nimbleness can be particularly beneficial in the real estate sphere, where tight closings are common and not securing funding in time can be disastrous. Owners and developers that lack the equity, or the balance sheet required by traditional lenders, or those requiring a higher LTV loan than a bank can offer may also turn to debt funds for financing.
Trust deed investing is simply investing in loans secured by real estate. Most trust deed investments are relatively short-term loans (with many loans two years or less) made to professional real estate developers that are buying properties and/or fixing up these properties and reselling them for a profit.
These professional real estate developers choose to work with private money lenders in many cases because of the strict set of criteria and cumbersome amount of personal information and paperwork required by institutional lenders. Since private money lenders primarily focus on the property itself as its collateral, in most cases there is no personal guarantee requirement.
Further incentivizing developers to work with private lenders, banks take months to process, approve, and disburse a loan. In contrast, private money lenders can close in as fast as seven business days. Lastly, most of these loans are short-term loans of 6 months to 2 years, so over the project’s lifetime, the extra percentage points on the loan often do not affect the borrower’s bottom line significantly.
For this reason, private money loans are an in-demand product that can command relatively high-interest rates.