Trust Deed investing, like most investments, involves some sort of risk. The most relevant ways to reduce the risk involved in a real estate trust deed investment is for each investor to educate themselves and, to work with a licensed, experienced financial expert. A skilled broker is adept at providing the following information regarding first trust deed investments:
- The Property’s Equity Level and Market Value
- The Borrower (the individual required to pay the trust deed) Credit Profile
- The Title Insurance Policy
- Loan Payment Service Options, and
- The Financial Instruments used to secure the debt
Relevant Financial Instruments Used to Manage and Enforce Trust Deeds
The Promissory Note
A Promissory Note identifies the lender(s) and the borrower(s).
It is the written promise a borrower (and a lender signs) to commit to repay (or an investor to provide) a specified amount of funds to be repaid over time. A Promissory Note can be structured as an installment plan or, as a lump sum payment due at a future date. It is a legal instrument that carries the weight of a common law contract if specific legal criteria are met: i.e. an offer, and an acceptance of said offer. Similar to other written contracts, a well crafted promissory note will delineate the conditions and terms established between two parties. This note delineates the interest rate, the initial amount of money lent, the due date, or the penalties for violating any provision of the loan’s repayment terms.
When both parties to the promissory note have executed the financial instrument, the promissory note will have met the minimum requirements to form a legally binding contract.
Trust Deed- The Promissory Note’s Security
A Trust Deed secures a Promissory Note. This is the legal document that is recorded as a lien on the title of the property – that which was financed by funds denoted in the promissory note. A Trust Deed (and its close relative, the mortgage) is the primary method of offering security when financing real estate. This is the way in which a Trust Deed works:
- A Trustor (aka the borrower) transfers the subject property, in trust, to a trustee, who is an independent 3rd party.
- The Trustee maintains the ‘conditional’ title for the note holder (aka the lender, or the beneficiary).
A Trustee is authorized to:
- Reconvey (i.e. detach) the Trust Deed from the property’s title when the lien is satisfied in accordance with the provisions delineated by the promissory note.
- Sell the property should the borrower default on the loan and find themselves facing a foreclosure
As noted above, a foreclosure is a legal action that occurs when the obligated borrower defaults on the promissory note upon which they are legally bound. A Foreclosure action begins with a filed ‘Lis Pendens’, which is Latin for ‘suit pending.’ A foreclosure is a legal action that involves the note holder’s ability to sell the subject property to a third-party bidder or, simply take title to the property. Generally speaking, a completed foreclosure action satisfies the defaulted debt.
Trust Deed investing always carries some risk, however, trust deed investors can use this legal method to recoup all or some of any losses experienced. Foreclosure is an intricate process but the most prudent way to attempt to minimize losses. Foreclosure matters are best guided by attorneys who specialize in real estate matters.
Investing in a trust deed essentially places the investor in the shoes of a lender. It is a great way to gain insight into how a bank underwrites and assesses the risk they are agreeing to undertake.