When you’re ready to buy your home, you’ll have the option of choosing between two types of financing: a mortgage and a deed of trust. So which one should you choose? It depends on your situation and what kind of loan works best for you, but it may not be as simple as you think.
The following guide will help you make an informed decision about which loan is right for you. Mortgage vs Deed of Trust
What is a mortgage?
In simple terms, a mortgage is a loan to purchase a home. The borrower (the home buyer) makes monthly payments at an agreed-upon interest rate and, over time, pays back both principal and interest to reduce their debt.
In most cases, if you fail to make your monthly payments or fall into arrears, you’ll risk losing your home.
Note that, with a mortgage, you don’t own your home until you’ve paid off what you owe in total.
This can take years and is one reason why mortgages are considered safe investments by banks and financial institutions.
Another benefit is that these loans often come with a bit of an upfront cost. At least when compared to other loans like credit cards, which require cash collateral but tend to carry higher rates. Mortgages also have tax benefits that can help offset some of your monthly expenses.
What is a Deed of Trust?
A deed of trust is a legal document that gives ownership of a property to the lender if the debtor cannot repay the loan. It is another form of security that helps protect your lender if you do not repay your mortgage.
The deed may or may not be recorded, depending on local laws. In some states, it is required that all deeds be recorded, while in others, deeds are generally recorded at the owner’s discretion and only if there is an issue with title or ownership (not necessarily related to a mortgage).
Also, read: Is Mortgage Tax Deductible? Here’s What You Need to Know.
In any case, you should contact your local jurisdiction before signing any documents. While many people believe the terms “mortgage” and “deed of trust” are synonymous, they are, in fact, two separate words with their own meanings. They are often found together, but never the same.
Why do you need both, and when are they needed?
A mortgage is a legally binding contract that allows you to borrow money from a financial institution (or other entity, like a family member) to purchase real estate. The lender will provide an advance on your down payment so that you can quickly purchase a home.
Monthly mortgage payments contribute to paying off your initial down payment and gradually repaying your principal and interest charges.
A deed of trust is the solution when you have real estate but no lender to fund the purchase. Such situations require a transfer of the title to the property to a trustee who serves as an intermediary between you and potential buyers.
Your monthly payments go toward repaying your debt to the trustee until it’s paid off. At this point, ownership reverts to you or goes into escrow until it’s sold again.
Common Questions & Answers
Mortgages and deeds of trust are used to secure real estate loans. The main difference is that you own your home outright with a mortgage, and your total equity is put into one loan secured by your property.
With a deed of trust, you have a second mortgage on top of any loans you may have taken out against your property.
A deed of trust protects against foreclosure and offers additional flexibility because it’s possible to sell or refinance without making extra payments or refinancing another loan first.
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On average, mortgages are better if your loan-to-value ratio (LTV) is high; deeds of trust tend to be better when LTVs are low. For example, if you buy a house for $200,000 and take out a $150,000 mortgage at 5%, your LTV is 80%.
If you then get an $80,000 home equity line of credit (HELOC), your total debt would be $230,000—and that’s considered an average amount in many markets.
Comparison chart
There are four main types of residential financing available in Michigan:
- conventional mortgage,
- FHA mortgage,
- VA mortgage,
- Deed of trust.
Each has different benefits and requirements that can affect your eligibility, so it’s essential to understand how they work before deciding on a lender or program. Use our chart to compare each type and determine which fits your situation best.
If you’re ready to apply, visit us at ABC Lending Group.
We look forward to helping you with all your financial needs!
A home loan is typically made by taking money from a bank or other lending institution and using it to purchase real estate as security against repayment.
A down payment is required, and private mortgage insurance (PMI) may be required if you make a down payment of between five percent and 20 percent. The cost varies based on factors like your credit score and loan amount; PMI typically runs from 0.25 percent to 0.5 percent of your loan amount annually but will stop once you have 20 percent equity in your home. Or when you’ve paid off half your loan amount, whichever comes first.
