When someone buys property, like a car or a house, they usually sign a loan agreement or promissory note. This agreement states that they will pay a certain amount of money within a specific time frame.
To ensure they get paid, the lender might ask for a security instrument, which can be a mortgage, deed of trust, or installment land contract. These instruments are legally binding, so both the lender and borrower need to understand what they are, how they work, and the legal implications.
What Is a Security Instrument?
A security instrument is a legally binding agreement between the lender and borrower or buyer and seller of a property. It provides a vehicle for the lender to enforce terms if the borrower fails to adhere to the loan agreement or promissory note terms. The security instrument also provides a way for the lender to recover some or all of the property value should the borrower default or the promissory note become invalid.
Unlike a loan agreement or promissory note, a security instrument is not concerned with the repayment terms. Instead, it focuses on enforcing the promissory note by transferring property ownership to the lender in the event of default.
Example
If you take out a home loan, you will likely sign a promissory note to pay monthly installments on your mortgage for 15-30 years. The bank handling your loan may also have you sign a security instrument in the form of a mortgage agreement, which allows the bank to take ownership of the property should you fail to repay your loan per the agreement terms.
Once the borrower satisfies the loan term, they receive a promissory note release and take full ownership of the property without further obligation to the lender.
Types of Security Instruments
Different types of security instruments apply depending on the circumstances of your purchase agreement.
| Mortgage | Deed of Trust | Installment Land Contract | |
|---|---|---|---|
| Definition | A real estate transaction directly between the borrower and lender. The borrower pledges real property as collateral for a loan. | Similar to a mortgage, but includes a trustee as a third party. The trustee holds the property title while the borrower pays off their financial obligation. | An installment agreement directly between the buyer and seller. The seller retains title to the property until the buyer pays for it in full. |
| Parties involved | Borrower (mortgagor) and lender (mortgagee). | Borrower (trustor), lender (beneficiary), and trustee. | Buyer (vendee) and seller (vendor). |
| Title | Legal title remains with the borrower. | Legal title is held by the trustee until the loan is fully repaid. | Legal title remains with the seller until the contract is fulfilled. |
| Foreclosure Process | Judicial or non-judicial foreclosure process may be used, depending on the terms of the mortgage agreement. | Non-judicial foreclosure process is common, often requiring notification to the borrower and potential court challenges depending on state laws. | Forfeiture clause may allow the seller to reclaim the property without refunding payments received in the event of default. Legal enforcement may vary by state. |
| Redemption Rights | Some states allow for redemption periods after foreclosure. | Redemption rights may vary by state, typically limited. | Enforcement of forfeiture clauses and recovery of property value may vary by state, potentially requiring more expensive legal action. |
| Default Risk | Defaulting on mortgage payments may lead to foreclosure. | Defaulting on payments may result in non-judicial foreclosure by the trustee. | Defaulting on payments may lead to forfeiture of the contract and loss of property. |
| Recording Requirement | Must be recorded in public land records. | Must be recorded in public land records. | Should be recorded, but requirements may vary by jurisdiction. |
| Transfer of Ownership | Ownership can be transferred freely through sale or inheritance, subject to the mortgage. | Transfer of ownership typically requires lender's approval or loan repayment. | Ownership transfer may be restricted until the contract is fully paid. |
| Role of Trustee | Not applicable. | Trustee holds legal title until the loan is repaid or foreclosed upon. | Not applicable. |
How Security Instruments Are Used in Real Estate
Although a promissory note establishes the payment terms for a real estate transaction, it does not necessarily establish consequences for non-payment. That is where the security instrument comes in.
The Role of Security Instruments
When you purchase a home or other real property, the lender may secure the promissory note through a security instrument. The instrument provides the lender collateral to recover the value of the loan if you default. In the case of a real estate transaction, the collateral is usually the property itself.
Common Security Instruments
In real estate, there are two common types of security instruments: mortgages and deeds of trust.
- Mortgages: Lender holds the mortgage while the loan is outstanding, allowing them to take possession and sell the property if necessary.
- Deeds of Trust: Similar to mortgages, but title is transferred to a neutral third party (trustee) who holds it for the lender’s benefit.
Importance of Security Instruments
- Enables lenders to recoup their investment by selling the property if the borrower defaults.
- Protects lenders from significant losses in case the borrower lacks assets to cover the loan.
Loan Documents
- Standard home purchases involve both a mortgage and a promissory note.
- Together, these documents cover loan amount, interest rate, payment terms, and the borrower’s repayment obligation.
Key Elements of Security Instruments
Understanding the different aspects of security instruments can help buyers, sellers, and lenders establish agreements that benefit everyone:
Involved Parties
Clarify who is involved in the transaction. This may include the buyer, seller, borrower, lender, or trustee. If any party represents an organization, such as a bank, include the name of the representative, their title, and the organization’s details.
Property Description
Describe the property in detail. This may include an address, lot number, or other location description for real estate transactions. If your security instrument is for a motor vehicle or other property, include the VIN, serial number, or additional identifying information.
This section should describe any damage or other existing conditions at the time of sale.
Loan Terms
While the promissory note or purchase agreement provides loan and repayment details, you should also include the following loan information in your security instrument:
- Loan amount
- Interest percentage and capitalization
- Repayment amount
- Installment schedule
- Specific conditions relating to the loan and repayment
Default and Foreclosure
Explain the consequences of default. This section should clarify the specific time frames for default and what remedies are available to the lender or seller should the buyer violate the payment terms.
Describe forfeiture, foreclosure, penalties, and potential legal action here. Be detailed about the forfeiture, selling, or foreclosure process and the options available to both parties. Include any information about arbitration or other forms of alternative dispute resolution.
Legal remedies for default and foreclosure may differ by state, so check your state laws before signing a security instrument for a real estate or other property transfer.
Signature
The borrower and lender may sign the security instrument, depending on the details of your transaction. Review state laws to understand the signature requirements for legal documents like promissory notes and loan agreements.
FAQs
When a mortgage is used as a security instrument, who holds the mortgage and the promissory note?
The lender holds the mortgage and promissory note when a mortgage is used as a security instrument. If there is a trustee, they will hold the title to the property until the loan terms are satisfied.
Who signs the security instrument?
The borrower and lender sign the security instrument when it is a mortgage or deed of trust. The buyer and seller sign if it is an installment land contract.
What’s the difference between a security instrument and a loan agreement?
The difference between a security instrument and a loan agreement is that a loan agreement establishes the payment terms for the loan, while the security instrument establishes a way for the lender to enforce the agreement and recover the loan value if the borrower defaults.
What’s the difference between a security instrument and a promissory note?
The difference between a security instrument and a promissory note is that a promissory note documents the amount and terms the borrower agrees to pay. The security instrument establishes collateral for the lender to recover the agreed amount if the borrower fails to meet the promissory note terms.
What’s the difference between a security instrument and a security interest?
A security interest is the lender’s right to the buyer’s assets. It is established by a document that confirms the lender’s security interest. This document is commonly referred to as a security instrument. Therefore, the security instrument is what establishes the lender’s right to the buyer’s assets, resulting in a security interest.
