A real estate sale can seem like a daunting task, but with an attorney on your side, you can sail through with ease. There are a few documents that you need to understand when entering into a real estate transaction: deed of trust, promissory note, and guaranty. Let’s walk through these documents so you can understand what is happening in a real estate transaction.
Deed of Trust
A deed of trust is a document that embodies the agreement between a lender and a borrower to transfer an interest in the borrower’s land to a neutral third party, a trustee, to secure the payment of a debt by the borrower. Essentially, this is a document that identifies the land and is held until the real estate is paid off. When a lender sells land to a borrower, the lender will hold the deed of trust as security until the borrower/purchaser pays off all the debt associated with the deed of trust, then the real estate is fully deeded to the purchaser.
A promissory note is a financial instrument that contains a written promise by one party (the note’s issuer or maker) to pay another party (the note’s payee) a definite sum of money, either on demand or at a specified future date. While a promissory note can be used in many contexts, it is commonly used in relation to a real estate transaction because many people cannot buy real estate outright (with cash). When signing or drafting a promissory note, the terms that should be included are: the sum of money to be paid, interest on the amount that will be charged, how long the note is for, and the monthly payments or lump sum payment that is required at the end of the term or on demand. Most promissory notes connected with the sale of property are for a term and certain timed payments rather than lump sum and on demand payments.
A guaranty agreement is commonly used in real estate transactions. This happens with a third party, called a guarantor, providing assurance of payment in the event the purchaser involved in the transaction fails to live up to their end of the bargain. This situation is similar for when a parent co-signs on a car loan for their 16-year-old child. A guarantor essentially guarantees that the borrower will pay the promissory note with their own money. If the borrower defaults on the note, the lender can call upon the guarantor to pay the debt. This gives the lender an additional level of comfort when giving a loan to a borrower on a property. A guaranty agreement is usually needed when the borrower does not have developed credit or does not have the liquidity needed to make the lender feel like the borrower will be able to pay the loan back without issue.
To best understand a real estate/property sale let’s walk through an example. Annie is selling a piece of property to Bobby’s business Bobby, LLC. Annie is going to finance the property sale herself. Bobby is thrilled by this because then he does not have to get a loan from a bank. Annie and Bobby will likely want to have a letter of intent or a term sheet between them so that both parties understand the terms of the agreement. This is where an attorney comes in. This term sheet will have terms such as the price, the interest rate, the property description, if a guaranty is needed, etc. This will be an important step to ensure that the parties are on the same page. Annie and Bobby, LLC will each have an attorney. One attorney will draft the term sheet and documents and the other attorney will review them. In this case, Annie decides to hire Charley as the attorney to draft the documents for and oversee this transaction. Bobby has his company’s attorney, Daniel, review what Charley has drafted.
Here are some of the terms on the term sheet:
- Purchase price: $100,000.00
- Interest rate: 4%
- Property: 123 Main St., Salt Lake City, Utah 84111
- Guaranty: required
- Term of loan: 10 years
- Frequency of payments: monthly
Once Annie and Bobby, LLC have determined the terms for the transaction, Charley has written up the term sheet, and Daniel has reviewed and accepted the term sheet, Charley will start putting the documents together for the sale and purchase. Charley will draft: a loan agreement for the general terms of the agreement, a deed of trust, a promissory note, and the guaranty.
Since a guaranty is required, Bobby asks his friend and co-owner of Bobby, LLC, Emily, to be the guarantor. To guaranty a property, the person pledging a guaranty must have a connection with the property. As co-owner, Emily can be the guarantor because she has an interest in the property. Emily has much better credit and more liquidity than Bobby or Bobby, LLC, which makes her a safer and more attractive option to guaranty the loan from Annie.
As Charley is drafting the agreements, she will make sure that the loan agreement has all the applicable terms for the actual exchange. The loan agreement would be a purchase and sale agreement if Annie were not also financing the loan. A purchase and sale agreement contains the terms of the real estate sale but would not reference the loan terms because the loan would be with another entity, like a bank.
Charley will ensure that the trust deed references the correct property, names Annie as the beneficiary, and names Bobby, LLC as the borrower. A trustee will be named to hold the trust deed while Bobby, LLC is paying off the loan. This can be a title company, attorney, or other entity that is set up to hold a trust deed. In this case, Charley will be the trustee. A trust deed will need to be recorded with the country recorder, so both Annie and Bobby, LLC will have to sign in front of a notary.
The promissory note will be between Annie and Bobby, LLC, where Bobby, LLC pledges to pay the principal amount to Annie. For a promissory note, only Bobby, on behalf of Bobby, LLC will have to sign the note. This is because Bobby, LLC is the only one promising anything in the note.
The guaranty will be drafted in a way to protect Annie if Bobby, LLC were to default on the promissory note, trust deed, and loan agreement. This will have certain representations and covenants that Emily will have to promise to and keep to continually assure Annie that she will be able to pay if Bobby, LLC defaults. The guaranty will need to be signed by Emily only.
Once Charley has drafted all of the documents, she will send them over to Daniel, Bobby, LLC’s attorney, for his review. If Daniel has any issues, he will redline the documents and send them back to Charley. This will continue until the two parties have reached an agreement on all of the terms for all of the documents.
When all of the documents are finalized, they will be sent to each party that needs to sign them. Bobby, on behalf of Bobby, LLC will sign the loan agreement, promissory note, and deed of trust (in front of a notary). Annie will sign the loan agreement and the deed of trust (in front of a notary). Emily will have to sign the guaranty. Once all of the documents are signed, the trust deed will need to be recorded with the county recorder. After that, everything should be good to go.
This is the most basic situation for a seller-financed real estate sale. This type of transaction can get as complicated as the parties make it, depending on the various terms. There are innumerable interest rates, pay-back structures, debt-ratio requirements, etc. that can make a real estate sale more and more complex. This is why an attorney is so important. Even if the sale is not seller-financed, there are many contracts and agreements that each party will need to enter into and that should be reviewed. It is always a good idea to have contracts reviewed by an attorney.
An attorney can help you with the ins and outs of a real estate sale, whether you are the seller, purchaser, guarantor, or financer. If you have any questions about real estate, selling and purchasing real estate, or other questions related to legal issues surrounding starting a business, we can help. I offer a free consultation. My direct dial is 801-365-1020, and you can email me at [email protected].