Trust deed investments is a way for a private investor to become involved in a property loan, often to a business. Unlike a mortgage, the arrangement is not made directly between the borrower and lender. Instead, the title to the property is held by a third-party. There are also some differences in the process if the borrower is unable to keep up repayments.
The main reason for the presence of a third party in trust deed investments is that there is commonly more than one investor lending money for a particular property. This can be useful for people who either don't have the money to invest in a full home loan, or would prefer not to bear so much risk. Usually, the limit is 10 investors for an individual loan.
In the event the borrower cannot repay, the lenders can file a notice of default. After a set period of missed payments, the lenders can force a foreclosure. In the resulting sale, the lenders must legally bid the outstanding loan balance. If another buyer bids a higher amount, the amount owed to the lenders is transferred to them from the proceeds. If there is not a higher bid, the lenders take legal possession of the property.
The third party in a mortgage investment is technically a trust. This holds the title to the property on behalf of the lenders, who are known legally as lender-trustees, and are the beneficiaries of the trust. Rather than a mortgage document, the borrower issues a promissory note for the loan amount. This is similar to an IOU, but is a legal promise and obligation to repay the money, rather than a mere acceptance of the debt's existence.
While individual trust deed investments can be split between multiple investors, it is also possible for there to be multiple trust deeds on the same property. This means the borrower is effectively taking out multiple loans, each of which can involve a trust with one or multiple lenders. Each trust deed is named to show its priority of settlement. The first trust deed must be settled in full before any money goes to the second trust deed, and so on. This means there is more risk of investors in a second trust deed losing out if the borrower defaults, which makes the investment less attractive. This is because a result the rate of interest paid by the borrower to the lenders is, as with a second mortgage, usually higher than on first trust deed investments.