Trust Deed Investing Introduction

Trust Deed Investments can provide substantial returns with minimal risk.  Investors have two options available to them for investing in trust deeds, purchasing an existing promissory note or making a loan directly.  While similar in function to traditional mortgages, the main distinction between the two types of investments is that trust deeds involve three different parties—the lender, the borrower, and the trustee.  The person who is appointed the trustee operates as an independent entity to hold the legal title to a property on the lender’s behalf until the borrower has completely paid off the loan, but if a default were to occur, the lender can take ownership of the property.

Although double-digit returns on trust deed investments that mortgage brokers present may sound tempting, you should still be wary.  Investors should thoroughly research a property’s title status and market value before investing in a potential trust deed based solely on the promise of a high return.  Investors can start their research by acquiring a Preliminary Title Report from the past ninety days and making sure that the property doesn’t have anything that could affect the property’s market value.  As with any investment you should conduct your own due diligence.  Some things to consider while doing your research are:  Does the property have inexplicable encumbrances?  Unsettled legal concerns?  Is there a considerable variation between the appraised value and the assessed value?

Since the FDIC and other government agencies don’t insure trust deed investments, they are vulnerable to borrower default and the ups and downs of the economy; an investor could lose some or all of an investment.  If a borrower were to file for bankruptcy, the foreclosure process could be affected, resulting in a lengthy process, all at the cost of the investor.

According to a publication by the Cushman Rexrode Capital Corporation, “The court could modify the terms of the loan by extending the due date, changing the interest rate and payment structure, or causing the priority of the loan to be subordinated to a bankruptcy court-approved financing plan.”

An investor can even purchase one hundred percent of a single trust deed by making whole trust deed investments, entitling an investor to full ownership of the promissory note.  When dealing with whole trust deed investments, a single investor must have sufficient capital to fund the entire loan amount in order to purchase a whole trust deed.  The lender then receives a promissory note, and the insurance documents are recorded in the purchaser’s name.

However, with fractionalized trust deed investments, multiple investors—no more than ten—can contribute money toward purchasing undivided interests in a trust deed.  The entire amount is shared between multiple investors, so investors with less money to invest tend to find this option more favorable.  If a disagreement about how to proceed arises, and the borrower defaults, complications can occur.

Mortgage pools function similar to mutual funds except the investors possess trust deeds instead of stocks and bonds.  The financial risk is reduced through the diversifying of investments over numerous trust deeds, making the investors limited partners in the mortgage pool.

Investors should also decide whether they want to invest in a first trust deed.  First trust deeds take precedence over successive claims and are recorded first.  Second trust deeds have a greater risk attached to them because the first trust deed holder’s claim must be settled first.  If there isn’t enough money to satisfy both debts, it’s the second trust deed holder who will lose money.

The purchase of a promissory note or the funding of a loan should be carried out through an escrow.  The escrow instructions should require the promissory note and deed of trust be delivered to you or an independent custodian on your behalf at the close of escrow.  An escrow allows for specific instructions for the conditions that must be met before money will be transferred to the borrower, including selection of the title insurance coverage, resolution of existing title issues, and recording the deed of trust.