Mortgages & Deeds of Trust -- Part 1

Mortgages (or, in some states, deeds of trust) have been utilized as the most common method of financing the purchase of real estate. They allow money to be borrowed to acquire real estate that will, in turn, serve as security for the loan. Real estate is generally regarded as strong security, and it is the mortgage instrument that provides lenders with that secured interest.

The mortgage (or deed of trust) is essentially a pledge of property as security for a promise to repay a loan. The loan itself is usually evidenced by a separate promissory note; the mortgage, on the other hand, pledges the property as security for the debt. Many mortgages are also full recourse (i.e., the borrower is personally liable for the obligation), so the mortgage securing the property effectively acts as a second source from which amounts borrowed can be repaid.

Deeds of trust (in states where they are allowed) differ from mortgages by adding a third party (a trustee) who holds the actual title to the property as security for the promissory note and has the power of sale in the event of a borrower’s default. Deeds of trust have definite advantages; their power of sale can be exercised much more expeditiously than a mortgage foreclosure, which generally requires a court proceeding. The actual form of the security document is similar in many ways, however, and the discussion of mortgage provisions in this article generally applies to deeds of trust as well.

We've described in an earlier blog post the state differences in foreclosure laws. These differences generally (but not always) run along the same dividing lines as those that divide deed of trust states from mortgage states, and can affect the ability of a lender to promptly foreclose in the event of a borrower default. Basically, non-judicial foreclosures (as in California and many other states) based on deeds of trust containing a power-of-sale clause enable the trustee to initiate a trust deed foreclosure sale without having to go to court. In judicial foreclosures, on the other hand, a lender must often wait for several mortgage payments to have gone unpaid, and then must pursue court action to prove the validity of its claim and to get the court’s approval to initiate foreclosure or to get a decree of sale.

Mortgages have traditionally been governed primarily by state laws, which can vary markedly. With residential mortgages, the federal government has in recent years acted to preempt state laws in some areas (overturning usury laws, eliminating restrictions on due-on-sale clauses, and allowing for prepayment arrangements), and the quasi-governmental agencies (e.g., Fannie Mae) that support the secondary market for residential mortgages have led to widely used standardized forms in that sector. Commercial mortgages, however, have largely been unaffected by this standardization trend.

Mortgages should always be recorded with the local county office. While recording isn’t essential to the mortgage’s validity, it does give others notice of the mortgage’s existence – and that notice serves to protect the lender’s priority over other potential claimants against the borrower’s estate. In most states, a lien that would otherwise be subordinate to the mortgage might gain priority over it if that junior lien is recorded and the mortgage is not.