The term mortgage is widely used. The truth is most of the time and in most states you have what is called a trust deed loan. To learn more, view are the states and what form of lending on housing they use by visiting the Mortgage States and Deed of Trust States Guide.
This article applies to trust deed states.
If you have ever bought a house, you probably remember the loan broker presenting you with a pile of paperwork bigger than some of your school textbooks and after telling you these were your loan documents. As your hand begins to cramp from the nine hundredth signature, you probably thought “I know I’m borrowing a lot of money here … but does the contract need to be this complicated?”
Actually, it’s less complicated than you think. Most of that tree-killing contract consists of disclosures and indemnifications that have little to do with the loan. All real estate loans, whether we’re talking about a home mortgage, commercial loan, construction loan, or bridge loan, consists of just two key documents with a handful of key terms to look for.
The two key documents are sometimes referred to as the deed and the note. If you ask your loan broker for these two documents, they will know exactly what you are talking about.
The Deed of Trust
All property ownership is made official with a “deed.” If there is no loan attached to the property, this is usually a grant deed. With a loan attached, however, that deed will almost always be a deed of trust.
The deed of trust is recorded in the name of the buyer, making that buyer the “owner of record” on the property. However, a deed of trust comes encumbered with a lien, the legal right of the lender to claim the property through the judicial proceeding of foreclosure if the deed holder defaults on the loan agreement.
The Promissory Note
The note or promissory note records the particulars of the loan and refers to the deed of trust to which the loan applies, effectively identifying the property as collateral for the loan and subject to foreclosure if the buyer defaults on the loan.
Before the buyer commits to the loan, they are usually presented a term sheet outlining the key terms of the loan. The buyer should carefully examine the note to make sure the following terms agree with what they expected from the term sheet:
- Principal Balance: The total amount the lender will be lending to the borrower for the purchase of the property.
- Interest Rate: Usually expressed as an annual percentage rate (APR), this is the fee the borrower pays the bank on an annual basis for the use of the money.
- Amortization Rate: The amortization rate, expressed in years, refers to how many years of monthly payments of principal and interest it will take for the borrower to pay the entire loan down to a zero balance. For example, a loan with 30 years of amortization means that if the buyer makes the minimum scheduled principal and interest rates the balance will be zero and the debt is retired after thirty years, or 360 monthly payments.
- Loan Term: When the loan comes due in full. Residential loans often have no term other than their amortization period, but commercial loans often have terms that are shorter than their amortization period. A 30-year amortization will usually mean lower payments than a 20-year amortization, but the loan itself could be due in full after five or ten years. Bridge loans or hard money loans could have terms as short as two or three years. If you want to keep the property longer, you would have to refinance.
Other Terms to Look Out For:
- Disbursement Schedule: Construction loans may pay out a balance at closing for the purchase of the property, but the lender may hold back money for construction costs until they come due. This schedule of when construction principal can be unlocked and released is called a disbursement schedule.
- Escrow: A bank may require payments to be made into an escrow account to cover taxes, insurance, and capital repairs—all expenses that could undermine the value of the collateral property or even cause it to be seized if the property owner is neglectful. The lender could pay tax bills and insurance or contractor invoices directly, or release funds when you provide proof of your own payment.
- Balloon Payment: If a loan has a term that comes due before it is fully amortized, the remaining principal will immediately become due. This repayment of the remaining principal is called a balloon payment.
- Interest-Only Period: Some loans do not require principal payments for the first year or several years. This period where only interest payments are due is creatively called the interest-only period, sometimes abbreviated I/O. Hard money loans are often interest-only for their entire short term.
- Prepayment Penalty: Lenders who write long-term real estate loans often expect them to perform for a period of years. If the buyer tries to pay them off early, they fall short of projected revenue. Lenders may write prepayment penalties in the note, which in the early years of the loan can be quite hefty, eating up the proceeds of any sale.
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