Sometimes clients — especially those who are providing seller financing loans — want to know the differences between a deed of trust, contract for deed, and mortgage. There are certain differences between these three debt instruments that should be considered prior to providing a loan.
The Basics of a Mortgage
At the most basic level, a mortgage is a debt instrument, secured by the collateral of specified real property that the borrower is obligated to pay back with a predetermined set of payments. If the borrower does not make payments, then the lender has the option to accelerate the loan balance, and ultimately to file a judicial foreclosure.
Deed of Trust
A deed of trust is another debt instrument, secured by the collateral of specified real property, that the borrower is obligated to pay back with a predetermined set of payments. Unlike a mortgage, however, a deed of trust involves three parties, rather than two — a lender, a borrower, and a trustee. If the borrower does not make payments, then the trustee has the option to accelerate the loan balance, but unlike a mortgage, the trustee is also given the power to sell the property at a private sale rather than go through the judicial process of foreclosure.
In some states, a judicial foreclosure can take as long as 2 years, whereas a private sale can be accomplished in only a few months. There are disadvantages to a private sale, however, in that in some states, deficiency judgments cannot be obtained without going through a judicial foreclosure. A deficiency judgment is an unsecured money judgment against a borrower whose mortgage foreclosure sale did not produce sufficient funds to pay the underlying loan in full. A deed of trust, if drafted properly, should give the lender the right to choose whether to sell the property through a private sale or file a judicial foreclosure, to preserve the right to a deficiency judgment if the lender does not believe the sales proceeds will satisfy the full amount of the underlying loan.
Contract for Deed
A contract for deed (also known as an installment sale contract) is similar to a deed of trust and mortgage, but the lender (or seller) will maintain “legal” title to the real property until the loan is paid in full, until such time the buyer has an “equitable” interest in the property. Typically, at the same time as the contract for deed is signed, two deeds are signed and held in escrow by a title company during the loan term. A quitclaim deed from the borrower to lender conveying the property to the lender, which is recorded upon default by the borrower; and a warranty deed form the lender to borrower conveying the property to the borrower when the loan is paid in full. Ideally, upon default, the lender can take back the property simply by directing the title company to record the quitclaim deed which will divest the borrower of any remaining interest in the property. Practically, however, the lender may need to go through a judicial process to accomplish the same.
Speak with an Attorney
There are other differences between these debt instruments as well, and in some states deeds, particularly in the eastern United States, deeds of trust are not statutorily allowed. In any event, you should definitely speak with a real estate lawyer, like a real estate lawyer in Belgrade, MT, prior to entering into a seller financing transaction to determine what debt instrument is best suited for your particular circumstances.
Thanks to Silverman Law Office, PLLC for their insight into some of the differences between debt instruments and how to implement them.