In a home loan transaction, the lender commonly requires the borrower to sign a mortgage or a deed of trust. These documents set up the terms of the loan, and are similar in several ways. For example, each one gives the lender the right to sell the home through a process called foreclosure if the borrower does not abide by the terms of the loan or make the loan payments (the lender uses the sale proceeds to pay off the loan). However, mortgages and deeds of trust differ in two major ways:
- the parties involved, and
- how the foreclosure process generally works.
Read on to learn about the similarities and differences between mortgages and deeds of trust, as well as how the differences could affect you if you fall behind in your loan payments.
Mortgage and Deed of Trust Similarities
Mortgages and deeds of trust normally have the same general provisions (clauses). For example, most mortgages and deeds of trust require the borrower to, among other things:
- have homeowners’ insurance
- keep the property in good condition, and
- refrain from keeping hazardous substances on the property.
Mortgages and deeds of trust also usually require the lender to give the borrower a written notice before starting a foreclosure. Lenders also typically have to provide the borrower with a certain amount of time to avoid a foreclosure by getting current on the loan.
In some states, like Wisconsin and Florida, lenders use mortgages to create security interests in properties. In other states, like California and Colorado, lenders use deeds of trust—or similarly named documents. For example, in Georgia, the contract that gives the lender a security interest in the property is a “Security Deed.” A Security Deed is basically a deed of trust.
Mortgages and Deeds of Trust Have Two Major Differences
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 is a two-some; a deed of trust is a trio:
- 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 payments on the loan and end up in foreclosure (see below). Because the lender chooses the trustee (and trustees make money from handling foreclosures), trustees usually look 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.
Generally, in states where lenders use mortgages, the lender forecloses by filing a lawsuit against the borrower in court. This 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.
In states where lenders use deeds of trust, the lender can foreclose out of court in 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.
A nonjudicial foreclosure often involves:
- sending the borrowers a notice of default that informs them that they are 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. However, some exceptions to this general rule exist. Lenders in Alabama and Michigan, for example, 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.
How to Find Out if You 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. However, 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.
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 mortgage servicer (that’s the company to whom you make your payments), 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.
If you have questions about what type of foreclosure process the lender is likely to use in your situation, consider contacting a foreclosure attorney.