A deed of trust and promissory note are two legal documents commonly used in real estate transactions in some states. These documents are typically required by a lender as a condition of providing a loan to fund a real estate purchase, such as when you buy a home. The documents are also used in connection with home equity lines of credit and any other types of borrowing against your property equity.
Borrowing money from any financial institution, such as a bank or credit union, involves a promissory note. This note is your written promise to repay the loan according to specific terms. In general, the terms of a promissory note include the amount borrowed, the interest rate for the loan and the manner in which it will be repaid -- for example, the number and amount of monthly payments. If you fail to make any required payments, you'll be in breach of your promise to repay the loan. Your lender can file a lawsuit against you to collect any missed payments and the balance of the loan due under the promissory note.
Deed of Trust
When you borrow money in connection with a real estate translation, your lender requires you to sign a deed of trust in addition to a promissory note. The deed of trust is a common real estate document used in more than a dozen states, including Arizona, California, Colorado and Texas. The purpose of the deed is to secure payment of the promissory note by using your real estate as collateral. Although the most common use of a deed of trust and promissory note is for a loan to purchase real estate, these documents are used for any loan in which you use your real estate as collateral to repay the loan. For example, the loan may be used for a business purpose, such as purchasing new equipment or machinery.
Power of Sale
A unique feature of a deed of trust is a provision commonly included in the document known as the "power of sale." When you signed the deed of trust, you made an agreement with two other parties: a beneficiary -- who is your lender -- and a trustee -- a third party who is usually a title company or other professional trustee. You're referred to as the trustor in the deed of trust. The significance of this agreement primarily comes into play if you fail to make any payments on the promissory note. This is called a default in the deed of trust. When a default occurs, your lender can instruct the trustee named in your deed of trust to foreclose on your property to recover the remaining monies due on the promissory note. The exercise of a power of sale is referred to as a non-judicial foreclosure because neither the trustee nor your lender has to file a lawsuit to perform the foreclosure.
Compared to a Mortgage
A total of 29 states allow lenders to use a promissory note and deed of trust with a power of sale to secure repayment of loan. In the remaining states, the only way to use your real estate as collateral for loan is by obtaining a mortgage. This transaction requires only two parties: your lender and you. Although lenders in these states can foreclose on your mortgage if you default, the lender must file a lawsuit to foreclose.