Trust deed investing is an investment in well, trust deeds. So let’s start by understanding what a trust deed is.
In a real estate transaction involving a loan, the primary parties include the seller, the buyer (who is also the borrower), the lender and an escrow company. In the United States, there are trust deed states and mortgage states. We’ll cover mortgages in another post, but they are somewhat similar instruments. Most investors simply refer to trust deed investing or mortgage investing as “note investing”.
In a trust deed state, the documents involved include a title deed, a trust deed, and a promissory note. The title deed can be a warranty deed, quit claim deed or other type of deed, but for the purposes here, just know that it means a document evidencing title. Kind of like a car title. Kind of.
Anyway, the buyer/borrower enters into an agreement to borrow funds from the lender. This is usually in the form of a promissory note, which is a promise by the borrower to pay the lender. The lender puts the funds into escrow to be held until closing. The escrow company – which is often a title company – conducts a title search, issues a policy insuring title and draws up a title deed. The deed – which is evidence of title – states the names of the transferring party (the seller) and the recipient (the buyer). The deed is filed with the county recorder’s office showing the change of ownership and alerting the world as to who owns the property.
The Trust Deed, on the other hand, is a document delivered by the borrower to the lender which acts as security or collateral backing up the borrower’s promise to pay the lender. It gives the lender the right to effectively sell the property in order to get its money back in the event the borrower doesn’t do certain things – like pay on the promissory note.
Usually, the title company or lender has their attorney draft the documents. The trust deed is a much bigger document than the title deed because it spells out all sorts of terms between the borrower and lender. Things like when the loan is considered in default, when the lender can foreclose, what rights each party has in the meantime and so on.
The borrower delivers this trust deed to a trustee who holds it in trust for the benefit of the lender. The borrower is therefore also the Trustor. The title company is the Trustee and the lender is the Beneficiary. A deed of trust is filed with the county recorder’s office as well, and notifies the world that the lender has rights to the asset as security for it’s loan. The trust deed therefore acts as a secured lien against the property.
Trust deed investing involves another party to the transaction.
The lender who originated the loan may want the money sooner than the promissory note allows. The lender and the trust deed investor would therefore enter into an agreement whereby the lender would assign its rights in the deed to the investor. The investor would pay off the lender and step into the lender’s shoes. The original borrower would continue making payments and all of the terms would remain the same, except that payments would now go to the investor.
As an example, let’s say you buy a house for $200,000. You put 25% down ($50,000). Then – through your title company or attorney – you issue a promissory note to the lender for $150,000, backed by a trust deed. Terms are for 30 years at a 5% annual interest rate, payable in monthly payments.
Let’s say the lender earned some upfront points on the deal and got some additional fees putting the loan together. The lender collects payments for a couple of years then decides to sell the loan so it can re-lend the money and collect more points and fees. A trust deed investor comes along and buys the rights. Why? Well, for one, the rates that banks charge for interest on real estate loans is higher than what banks pay on CDs or money markets. The trust deed investor can therefore get a higher rate by buying the loan than by being a depositor. Also, some loans may have gone delinquent and the banks would rather just sell the loans at a discount versus navigating through the foreclosure process. There are a host of reasons.
In any event, trust deed investors play a huge role in adding liquidity to the lending markets because lenders know they have a pool of buyers ready to provide them capital, if necessary. This gives lenders a greater comfort level in lending. Lending drives the economy because the more folks can borrower, the more they buy and invest.
Most people don’t hear much about trust deed investing because deals are typically done privately by large banks and investors on Wall Street. However, they are becoming more mainstream, everyday. There are plenty of opportunities today for anyone to buy and invest in notes.
Trust deed investors get a high return on investment and have their investment backed by a solid, tangible asset that can be sold to get their money back if the borrower defaults. Trust deed investors are offered a chance to invest in real estate without really needing to manage property and the returns can be just as high – if not higher. You can buy some notes at a substantial discount to face value and they can be bought, sold and traded like any other instrument.
If you want to diversify your portfolio as an investor, you might consider trust deed investing. It’s definitely worth a look. Trust deed investing is much simpler than wading through volumes of financial statements on pubic companies and much less hassle than owning real estate rentals. Your investment is secured by solid collateral that can’t get up and walk away. Legal documents defining your rights are recorded by the government and your rights are established from decades of case law and millions of transactions.
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