In a home loan transaction, the lender commonly requires the borrower to sign a mortgage or a deed of trust, along with a promissory note (specifically, a "mortgage note"). These documents set up the terms of the loan.
A mortgage and a deed of trust are similar in several ways. Each one creates a security interest in the property, giving the lender the right to sell the home through a process called "foreclosure" if the borrower doesn't abide by the terms of the loan or make the loan payments. The lender uses the sale proceeds to pay off the loan. But mortgages and deeds of trust differ in two major ways: the parties involved and how the foreclosure process generally works.
With a note, you promise to make periodic payments, usually monthly, to repay the borrowed amount. Only those who sign the note are personally liable for the debt. Being on the mortgage or deed of trust doesn't necessarily mean you're responsible for repaying the loan.
How Are Mortgages and Deeds of Trust Similar?
Mortgages and deeds of trust normally have the same general provisions (clauses). For example, most mortgages and deeds of trust require the borrower to have homeowners’ insurance, keep the property in good condition, and refrain from keeping hazardous substances on the property.
More Similarities Between Mortgages and Deeds of Trust
Mortgages and deeds of trust also usually require the lender to give the borrower a written notice, called a "breach letter," before starting a foreclosure. Lenders also typically have to provide the borrower with a specific amount of time to avoid a foreclosure by getting current on (reinstating) the loan.
Which States Use Mortgages? Which States Use Deeds of Trust?
In some states, like Wisconsin and Florida, lenders use mortgages to create security interests in properties. Lenders in other states, like California and Colorado, typically use deeds of trust.
Other states use a similarly named document. In Georgia, the most commonly used contract that gives a lender a security interest in a property is called a "security deed."
How Are Mortgages and Deeds of Trust Different?
Although mortgages and deeds of trust accomplish the same goal—to make your home a source of repayment if you default on the loan—they differ in two major respects, explained below.
The Parties Involved In the Transaction
A mortgage has two parties, while a deed of trust has three:
- A mortgage has two parties: a "mortgagor" (the borrower) and a "mortgagee" (the lender).
- A deed of trust, however, has three parties: the borrower, the lender, and a "trustee." The trustee obtains legal title to the secured property when the loan is taken out and holds it until the borrower pays the debt in full. Depending on state law, the trustee might be an individual, such as an attorney, or a business entity, like a bank or a title company.
In theory, the trustee is a neutral party, but the lender usually chooses the trustee, who might also be affiliated with the lender or the lender's attorney somehow. The trustee becomes important if you stop making the loan payments and end up in foreclosure.
Because the lender chooses the trustee and the trustee makes money from handling foreclosures, the trustee usually looks out for the lender—not the borrower—in a foreclosure.
Lenders Usually Foreclose Mortgages in Court and Deeds of Trust Out of Court
If you don’t make your loan payments or breach the terms of the mortgage or deed of trust in some other way, the lender will foreclose. The mechanics of foreclosing a mortgage or deed of trust depend on state law and the terms of the agreement.
Mortgages and Judicial Foreclosures
Generally, in states where lenders use mortgages, the lender forecloses by filing a lawsuit against the borrower in court. This process is called a "judicial foreclosure."
If the lender wins the suit, it gets a judgment that allows it to sell the property and use the proceeds to repay the loan. Judicial foreclosures normally take at least several months to complete and as long as a few years in some states.
Deeds of Trust and Nonjudicial Foreclosures
In states where lenders use deeds of trust (and in a few that use mortgages) that contain a power of sale clause, the lender can foreclose out of court using a process called a "nonjudicial foreclosure." Here’s where the third party, the trustee, enters the picture.
The trustee’s main function is to manage the foreclosure process and sell the property at a public auction if the borrower defaults on payments. State law typically requires trustees to act impartially in foreclosures. But because trustees have a financial incentive to keep lenders happy, they sometimes fail to return borrowers’ phone calls or acknowledge letters from borrowers, even if a borrower provides evidence of wrongdoing on the part of the lender or servicer.
A nonjudicial foreclosure often involves:
- sending the borrowers a notice of default that informs them that they're behind in payments
- recording the notice of default in the land records office
- giving the borrowers a notice of sale, and
- publishing information about the sale in a newspaper.
Nonjudicial foreclosures are ordinarily much shorter than judicial ones, taking just a few months or less to complete in most cases.
So, the general rule is that lenders typically foreclose mortgages through the courts, while deed-of-trust foreclosures happen without court involvement. But there are some exceptions to this general rule. For example, lenders in Alabama and Michigan use mortgages, but foreclosures are ordinarily nonjudicial. In these states, the terms of the mortgage contracts, along with state laws, allow lenders to conduct nonjudicial foreclosures of mortgages.
Also, in states where deeds of trust are normally foreclosed nonjudicially, the lender can choose to foreclose through a judicial foreclosure. This often happens in situations when the deed of trust has a flaw. For example, if the deed of trust contains an incorrect legal description for the property, the lender will likely choose to file a lawsuit in court so that a judge can officially clear up the issue.
Does It Matter Whether I Signed a Mortgage or a Deed of Trust?
If you’re facing a possible foreclosure, it’s helpful to know whether you’ve signed a mortgage or a deed of trust. Unless you fall within the exceptions mentioned earlier, you’ll have an idea about whether the lender is likely to foreclose judicially or nonjudicially.
If you’re facing a judicial foreclosure and believe you have a defense to the foreclosure, you’ll get a chance to bring it up to the court. But if you’re up against a nonjudicial foreclosure and think you have a defense to the foreclosure, you’ll need to file your own lawsuit to get the issue before a judge.
Because nonjudicial foreclosures are ordinarily much shorter than judicial ones, you need to start thinking about hiring a lawyer right away if you want to fight the foreclosure in court.
Did I Sign a Mortgage or a Deed of Trust?
To find out whether you signed a mortgage or deed of trust when you took out your home loan, you can:
- read the documents you received at the loan closing
- ask your loan servicer, or
- go to your local land records office and pull up the recorded document. (Lenders record mortgages and deeds of trust in the county records.) You might be able to do this online. Look at the title of the document, which will indicate whether it is a mortgage or deed of trust.
The Mortgage Note: Like an IOU
The "note" is the contract a borrower signs with a lender to borrow money. A promissory note is basically an IOU: a signed agreement to repay funds the borrower gets from the lender. Only those who sign the promissory note must pay the lender back the borrowed amount. In a mortgage loan transaction, the promissory note is called a "mortgage note."
The note states that the borrower promises to repay the loaned money and includes the terms for repayment. For example, a typical note will specify:
- the total amount of the loan
- the interest rate
- the amount that the borrower must pay to the lender each period (again, usually each month)
- the late charge if the borrower doesn’t make payments on time, and
- how long the borrower gets to repay the loan.
If you make all the required payments and completely pay off the loan, usually after many years, the lender marks the note as "paid in full" and gives it back to you.
However, if you don’t make the payments, the lender still has a way to get repaid: by using the mortgage or deed of trust as a basis for foreclosing on your home.
Talk to a Lawyer
If you have questions about what type of foreclosure process the lender is likely to use in your situation and how foreclosure procedures work, consider contacting a foreclosure attorney.