You have recently come into some money. You are thinking you would like to grow it by lending it out. Fortunately for you, an extended family member, he is an accomplished real estate investor. He asks you to fund his next acquisition with a standard promissory note. But a friend advises that you use a deed of trust. Do you know why?
Promissory notes and deeds of trust are pretty typical in the hard money gain. Actium Partners, a hard money firm located in Salt Lake City, explains that a typical lender will not make a hard money loan without a deed of trust. Promissory notes alone are insufficient. Actium says that promissory notes do not provide adequate security. You need a deed of trust (or trust deed) for that.
A Promise to Repay
The word ‘promissory’ is more or less the adjective form of the word ‘promise’. Therefore, a promissory note is just a promise to repay. It is a promise in written form. Because the promise is in writing, a promissory note can make collecting on a bad debt easier. But the promissory note has one fatal flaw: it is a private note between two parties. It is not recorded anywhere.
A belligerent debtor could argue that a promissory note is invalid. He could argue that he never signed the note. Lender and debtor could wind up in court while the judge is looking at one person’s word against another’s. How do you settle that sort of thing amicably?
More Teeth With a Trust Deed
In the hard money industry, lenders like Actium Partners utilize both promissory notes and trust deeds together because the trust deed adds teeth. A trust deed is filed in the same county as the property in question. It provides a legal document dictating ownership of a property. And when combined with a promissory note, it is the legal equivalent of a mortgage.
Trust deeds work a little bit differently, as implied by their name. A hard money transaction utilizing a deed of trust would actually result in the property’s deed being transferred to a third-party who holds it in trust. That third party can be an attorney, a title company, or any other entity the two parties agree on.
As the trustee, the third party maintains legal control while the borrower enjoys all the practical rights of owning the property. However, the deed is not transferred to the borrower until the loan is completely paid off. In the event of default, the lender can exercise its interest in the property to satisfy the debt.
Advantageous to the Lender
Hard money lenders insist on deeds of trust because of the advantage they derive from them. A trust deed transaction is a lot easier to foreclose on. Trust deed transactions are also easier to administer on the front end. No matter how you cut it, it is advantageous for hard money lenders to utilize trust deed transactions instead of traditional mortgages.
By the same token, borrowers gain something in that they don’t have to go through all the time, work, and pressure of having to obtain a traditional mortgage. Hard money loans are easier to get. They require significantly less documentation and can be arranged in days rather than months. It’s all possible because of the way trust deeds work.
As a private lender looking to grow your money, loaning to a real estate investor isn’t a bad idea. Just be sure you know what you are doing first. Work with an attorney and, by all means, utilize trust deeds in addition to promissory notes.