What is a Deed of Trust and why are we hearing so much about it?
The simplest definition is that a deed of trust or ‘Trust Deed” is a collateralized loan held against a piece of property or a mortgage. However, there are different aspects of a Trust Deed like:
- Who funds the loan?
- Who is borrowing the money?
- What is the amount of the loan?
Once you understand the basics of a deed of trust, then it isn’t hard to see why it has become a very popular investment strategy. We wrote this article to answer the question “What is a deed of trust and why are we hearing so much about it?” To begin, let’s look at how a deed of trust is similar and different than a traditional mortgage.
What is a deed of trust and how is it different than a mortgage?
A Trust Deed is similar to a mortgage, but there is one key difference. A standard mortgage is issued between a private borrower, such as someone buying their first home. A typical mortgage is funded by a banking institution like Bank of America, Wells Fargo, Chase, etc.
A Deed of Trust is similar in the sense that all the same general parties are involved i.e. a borrower, a lender, an interest rate, and a piece of property that is held as collateral for the loan. The key difference is in how the loan is funded. With a typical mortgage, the bank finances the loan. With a Deed of Trust the financing comes from private sources like individual investors or small investment firms. That means that a Deed of Trust can be funded by IRAs, cash, or other types of approved money sources. Funding for a Trust Deed is often referred to as “alternative funding” or “hard money” and is usually loaned out at a higher interest rate. Understanding that Trust Deeds are funded by private sources is the most important part of realizing why they have gotten so much attention recently.
What is a Deed of Trust and why is it getting so much attention?
As we mentioned before, the key aspect of a Deed of Trust is that it can be funded by private lenders. That means that Deeds of Trust can act as a form of investment strategy. In other words, a person can use their self directed IRA (or other approved money source) to loan money on a hotel, apartment complex, or even a rental home. Using an IRA to loan money on a piece of property has a couple unique benefits that are making it so popular. First, the interest rates on these loans can be higher than many other traditional investments; the returns can also be more consistent and predictable over time. Second, the investment is backed by collateral. That is right, if for some reason there is a default on the loan then the lender has rights to the property in the deed. This adds a whole different level of security to the Trust Deed investing strategy that is not common in other markets.
Now, if we take a look at the real estate industry we see that there is significantly tighter lending policies with the banks. We also see that there are excellent buying opportunities in different real estate markets being capitalized on very quickly. These two things combined have been a significant factor in the increasing demand for alternative funding and hence the demand for Deeds of Trust. Ultimately, it boils down to a combination of supply, demand, and opportunity.