Many people like the idea of making money from what they invest. It can be tricky though and the rate of return can be minimal. That is why many people are interested in trust deeds. The risk is low but the return can be several times what you invest in it. However, there are some essential things you need to understand before you jump into such investments. Learning the basics will help ensure you have the best chance of making money.

Promissory Note

You need to have a solid understanding of what a promissory note is. This is a promise that is in writing with all parties involved. Basically it covers the agreement terms for repaying the money that was loaned. It discusses the:

1. loan amount or principal
2. interest rate
3. frequency of repayment or debt service
4. loan due date
5. any penalties for late payments
   

When a borrower gets the funds for property they wish to own, they have to sign such a promissory note. They need to take the time to read over every single part of it. Anything that isn’t understood needs to be explained before it is signed. After it is signed, the borrower has agreed to all of the outlined terms.

A promissory note will also include information about what will happen of all of those terms of the agreement aren’t met. For example there may be late charges when a payment is 10 days late. In many instances there are also penalties that apply when a borrower prepays in advance. In the promissory note, the lender (note holder) and the borrower are also identified - in black and white.

Obtaining a promissory note

Next you need to understand how such a promissory note is obtained. When you decide to invest in a trust deed then you either are lending the funds to the borrower or buying a promissory note that already exists. There are rates in place that can’t be exceeded with that process so that predatory lending can be reduced. The ceiling that exists can vary by location so make sure you are aware of the laws that are in place in your area.

It is important to pay very close attention to those guidelines and ceilings. Severe penalties can be initiated if you exceed them. Most of the time you can get yourself involved with a deed of trust through a broker. Keep in mind that you will have to compensate them for their efforts. They are referred to as mortgage loan brokers (MLB) and their rates will also vary by location as well.

Securing your investment

You definitely need to understand how your investment is secured. Your deed of trust is going to be filed and recorded with the property that the funds were used for as collateral. There is no backing by the FDIC and you need to be well aware of that before you decide to invest in any deed of trust. There is always a risk involved when you invest in trust deeds.
You need to make sure all of the necessary information is covered in that promissory note. Otherwise you risk not being able to get your money that you invested back, or any return on it. Too many people assume that deed trusts are FDIC backed, so this point is one that you need to fully understand.

The borrower (trustor), once agreeing to the deed of trust, will place the title to their property in the hands of that third party (trustee). The trustee will do so on behalf of the lender or note holder (beneficiary) and they have some power that they can execute due to their status in all of this. First, they have the right and obligation to reconvey that title to the borrower once all of the terms of the promissory note have been satisfied completely.

Should that not occur though, they have the right to sell the property which is what we know as foreclosure. This process involves selling that property to the highest bidder in order to successfully get that debt paid off. Sometimes the property won’t sell this way though because the opening bid isn’t sufficient enough to satisfy that debt. Even if it does sell though it may not be enough to cover the entire amount that is still owed on it.

There are quite a few variables that can affect that outcome. For example the type of foreclosure process that is followed, the type of loan that is involved, the value of the property in today’s economy, and the type of investment that was made towards it. This is where the big risk comes into play with trust deeds. You may not be able to recoup what you invested or make any profit from it at all if you have to foreclose on the property. For example, if your property does not get third party bids and you bid only a full credit bid in a non judicial foreclosure sale, you will only get to recoup the original property value.

Sometimes you will be able to get the courts to help you generate some of that income though. For example they can make a judgment that you are eligible for the difference from what you were owed and what you were able to sell the foreclosed property for. However, even with such a judgment in place it can be extremely difficult to get the money from the borrower if they have no means to repay it.