What is a Deed of Trust?
A deed of trust (also known as trust deed) is a deed (a piece of paper usually recorded at the county) that gives legal title to real estate to a trustee. It secures the note (Mortgage).
There are three parties to this type of title. They are:
- The Trustor (Borrower),
- Beneficiary (Lender) and a
- The neutral 3rd part is called the Trustee.
They are written so that the lender gives money to the borrower to purchase a real property (home) and the borrower signs a deed of trust giving the power of sale for property to the natural 3rd party trustee to be held in trust for the lender. (I like to think the trustee takes the Deed of Trust and puts it in the top drawer of their desk and waits.) The borrower owns the property, but the trustee holds the title.
This is noted in the Deed of Trust and is called the ‘power of sale clause’ for example:
Borrower irrevocably grants and conveys to Trustee,
in trust, with the power of sale, the following described property.
The borrower makes the payments to the lender, not the trustee. If the borrower defaults and does not pay the Mortgage, the lender tells the trustee (they take the deed out of the top drawer and execute the power of sale) to sell the home. It’s the trustee who sells the home, not the lender. When the trustee sells the house at a trustee sale and gets the money, the trustee gives the money to the lender.
The trustee sells the home through the foreclosure process. The important part is that the trustee holds the title and sells the property, AND no court of law is involved. This is called a non-judicial foreclosure. No court, attorney, judge, or jury is needed. With a “power of sale” clause, the borrower has authorized the trustee to conduct a non-judicial foreclosure in the event of default. The trustee just does it, and when completed, the new owner receives a Trustee Deed. Foreclosure can start one day after the borrower is late, and the borrower has only 90 days to make the back payments, make the Mortgage current, and pay any fees for foreclosure or late fees. On day 91 the home can be sold at foreclosure, the ownership is transferred, and the original owner is out.
This is very quick and harsh on the borrower, but the borrower has one benefit. This benefit, in most cases, is that if the home is sold for less than the amount owned, a deficiency, the borrower is off the hook. Arizona is a non-deficiency state, but some states are not, and some deeds of trust don’t qualify for this exemption. In this situation, the lender usually sues the borrower for the deficiency. In Arizona, a non-deficiency state, there is usually no lawsuit for the deficiency.
Another problem for the borrower is if there is a deficiency. This is called a taxable event. This means that the deficiency is considered income to the borrower, and the borrower has to declare this as income on their income tax return. For example, if the original amount owned was $100,000 and the home sold at a foreclosure auction for $75,000, there is a deficiency (gap) of $25,000. The lender cannot sue for the amount they lost. We are a non-deficiency state. However, the US Government does not care and will want you to declare this as income on your tax return. (In most cases, the US Government does not require this at the time of this writing, but this can change).
A deed of trust is typically recorded with the recorder or county clerk for the county where the property is located as evidence of security for the debt. The act of recording provides constructive notice to the world that the property has been encumbered (there is a Mortgage on the property). When the debt is fully paid, the beneficiary (lender) is required by law to promptly direct the trustee to transfer the property back to the trustor (lender) by reconveyance, a Deed of Reconveyance, thus releasing the security for the debt.
Trust Deed differ from mortgages in that Trust Deed always involve at least three parties, where the third party (trustee) holds the legal title, while in the context of mortgages, the mortgagor (borrower) gives legal title directly to the mortgagee (lender) In either case, the equitable title remains with the borrower. Foreclosure on a mortgage is a judicial procedure (court of law) and is seldom used in Arizona.
Trust Deed is the most common instrument used in the financing of real estate purchases in:
Colorado, the District of Columbia,
West Virginia, whereas most other states use mortgages.
The periods for the “trustee’s sale” or “power of sale” foreclosure process vary dramatically between jurisdictions. Some states have very short timelines. For example, in Virginia, it can be as short as two weeks. In California, a non-judicial foreclosure takes approximately 112 days from start to finish. The process starts only when the lender or trustee records a “notice of default” no matter how long the Mortgage payments have been unpaid.
Trust Deed is subject to the rule “first in time, first in the right,” meaning that the beneficiary of the first recorded deed of trust may foreclose and wipe out all junior Trust Deed recorded later. If this happens, the junior debt still exists but becomes unsecured. If the debtor has sufficient senior secured claims upon their assets, the junior liens may be wiped out completely in bankruptcy.
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