Real Estate Financing Instruments

Did you know that all mortgages are not mortgages? The term "mortgage" is often generically used to refer to any type of security instrument used in real estate financing. But in actuality, there are three different primary devices that fulfill this roll: mortgages, trust deeds, and land contracts. Let's take a closer look at each one.

A mortgage is a two-party instrument in which a borrower (the mortgagor) gives a promissory note and a mortgage to the lender (the mortgagee). While the mortgagee is customarily a lending institution such as a bank, at times the property seller may finance the buyer directly. When this happens, the seller is the mortgagee and receives the mortgage as security for the balance of the property's purchase price.

The mortgage is typically recorded in the office of the county recorder. Once recorded, it provides public notice of the mortgagee's interest in the property. When the mortgagor pays off the balance of the mortgage, the mortgagee gives the mortgagor a satisfaction of mortgage document, which is also recorded. This document gives notice that the mortgagee's interest in the property is terminated.

Should the mortgagor default on the loan payments or fail to pay property taxes or insurance, the mortgagee can foreclose on the mortgage. In some states, the mortgagor is given a redemption period in which to cure the causes of the default and reinstate the loan before the property is liquidated by way of a foreclosure sale. Some states also provide a redemption period after the sale that allows the mortgagor to pay the full balance and reclaim the property. If the foreclosure sale brings less than the amount owed on the mortgage, some states allow a deficiency judgment to be placed against the mortgagor for the balance. In other states, deficiency judgments are unlawful or at least very difficult to obtain.

A trust deed is a three-party instrument in which the borrower (the trustor) makes payments on a note to a lender (the beneficiary). In order to provide the beneficiary with a greater measure of security, the trustor actually gives title to the property – in the form of a trust deed – to a third person (the trustee) to hold.

More than half of all the states allow trust deeds for real property, although some also use mortgages, as well. Like a mortgage, the trust deed is recorded to show the beneficiary's security interest in the property. When the trustor has paid the beneficiary in full, the beneficiary orders the trustee to return title of the property to the trustor. This is accomplished with a deed of reconveyance from the trustee to the trustor. Once this document is recorded, the beneficiary's interest is terminated. In the event that the trustor defaults on the loan, foreclosure can be implemented with relative quickness. After a short notice period, usually only a few months, the trustee will hold a sale to liquidate the property. Generally, no redemption period is provided after the sale.

A land contract (also known as a contract of sale or contract for deed) is a two-party instrument in which the seller (or vendor) retains title to the sold property and the buyer (the vendee) is merely given possession. The vendee doesn't receive a deed to the property until the vendor has been paid in full.

Land contracts are often used when the seller is financing a buyer who's making the purchase with a relatively small down payment. Since the seller retains the best possible security (title to the property), foreclosure is generally fairly quick and simple in the event of a default.