MORTGAGE AND DEED OF TRUST

Note on Mortgages and Deed of Trust

C.A. Fox

What follows is an effort to answer. very briefly, a student's question regarding the difference between the conveyance of interest in an estate to a creditor by mortgage to secure apyment of a debt compared to a a conveyance by a Deed in Trust to 3rd party as security for payment of adebt owed a creditor.

The basic differences are in the number of parties to the transaction and the debtor's ability to obtain a judicial determination of its rights after default.

Mortgage:

In a typical mortgage transaction, the debtor borrows money from the lender and signs a promissory Note, promising to repay the loan with interest under certain terms defining when and how the loan will be repaid (e.g., in a lump sum or in installments). At the same time, the debtor executes an instrument called a Mortgage, granting the lender an interest in some estate in property owned by the debtor and also containing a promise to repay the loan in accordance with the terms of the Note.. The debtor is called the Mortgagor because it conveys the interest to the lender. The lender, as the recipient of that interest, is called the Mortgagee.

If the debtor repays the loan in accordance with the terms of the note and mortgage, the mortgage is canceled or "satisfied' by an instrument signed by the Mortgagee. The Mortgagee has no more interest in the debtor's estate.

If the debtor does not repay the loan, it is in default under both the Note and the Mortgage. The Mortgagee now may bring an action to have the property sold to repay the loan. The Mortgagee's action is usually called an action in "foreclosure." It is really an action to terminate the debtor's right to pay the loan after it has become due and to have the Mortgage canceled. This right of the debtor to pay the debt after it is due and prevent the lender's resort to the estate is an equitable right called the "Equity of Redemption." An action in foreclosure is an action to cut off or foreclose, the equity of redemption. Foreclosure actions end with a sale of the debtor's estate by the sheriff or other judicial officer at a public sale. The proceeds of that sale (above the costs of the sale and any unpaid real estate taxes on the estate) are paid to the lender-Mortgagee. If the sale price is greater than the debt due (including interest), the surplus is paid to the borrower-Mortgagor. (It is not always as simple as this. Other parties may have claims against the estate that must be paid before the borrower will receive any of the sale proceeds, but do not worry about that now.) The action in foreclosure can take a long time and be expensive for the creditor, particularly where the sale does not bring enough money to pay the debt in full.

Deed of Trust:

There are three parties to a Deed of Trust transaction, although the basic purpose is the same as in a mortgage transaction. The borrower signs the Note promising the lender to repay the loan. It also executes a conveyance of title to its estate to a third party, the Trustee, who holds that title for the benefit of the lender (and the borrower). This conveyance is called a Deed of Trust. If the loan is repaid in accordance with its terms, the Trustee either reconveys the estate to borrower or cancels the conveyance, depending on the law and custom of the jurisdiction.

If the loan is not repaid in accordance with the terms of the Note and Deed of Trust, the borrower is in default. The borrower continues to have an equitable right to repay the loan (with interest) after it as become due (the equity of redemption). The lender may still bring an action in foreclosure to cut off that right. However, it need not do so. The Deed of Trust authorizes the Trustee to sell the property at the request of the lender when the borrower is in default. The Trustee's authority to sell is usually called a "power of sale" and is a matter of private law between borrower, lender, and Trustee. The Trustee's sale will cut off the borrower's equity of redemption without resort to a judicial proceeding. the proceeds of the sale are paid to the lender and, if there is any surplus, to the borrower in much the same way as the proceeds of the judicial sale in the case of a mortgage.

Both Transactions:

Both transactions are techniques for providing the lender with security for the repayment of its loan to the borrower. If the borrower is unable to repay the loan, the sale of the estate will provide at least some funds for that purpose. About half of the states do not recognize powers of sale under Deeds of Trusts. The only way the lender can realize the value of the security for its loan in these states is to bring an action to foreclose the equity of redemption. Even in these states, the federal government may use a power of sale to avoid judicial foreclosure under certain loans made or insured by it.

Of course, both transactions much more complicated than this short note indicates. Fortunately, you will not need to understand most of the issues surrounding these transactions for this course.

If you want to learn more right now, look at Grant S. Nelson & Dale A. Whitman, Real Estate Finance Law 壯 7.11 (Judicial Foreclosure) and 7.19 (Power of Sale Foreclosure) (3rd ed. 1994).

For more on the basics of a mortgage transaction, see Mortgage Primer.

C. A. Fox.
2/5/98

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