A collateral trust agreement is a written agreement between the lender, the borrower, and the trustee. The lender gives loan to the borrower in order to buy a house or property and in return, the lender gets the legal title of the property thus purchased. The role of the trustee is to hold the title of the property for the lender until the whole loan is repaid. Once the full payback is done, the trustee returns the title of the property to the borrower.
This type of agreement is also known as a deed of trust or a collateral trust certificate. The agreement is basically an extended version of mortgage loans where the collateral is the property which is bought by the borrower using the loan.
When Do You a Need Collateral Trust Agreement?
Any individual or an organization can use this loan to purchase a home or a property. The main purpose of the collateral trust agreement is to make sure that the borrower, the lender and the trustee legally adhere to the various terms included in the contact in order to avoid any future conflict. The agreement can be needed by the borrower and the lender in case of any disagreement in the future. The trustee might also need the agreement to enforce settlements among the parties.
Key terms of the collateral trust agreement include:
- Details of the borrower, lender and the trustee.
- Principal amount
- Description of the property which serves as a collateral
Inclusions in the Collateral Trust Agreement
In a collateral trust agreement, three parties are required to sign the contract. The three parties involved include:
- The borrower: a company or an individual who borrows money in order to purchase a home or a property which is further used as a collateral
- The lender: a bank or a private money lender who gives the loan
- The trustee: a third party who handles the collateral’s possession until the loan is paid in full by the borrower
The effective date is the last date by which the borrower needs to return the amount to avoid the sale of the property by the trustee. The agreement also includes the details of the property purchased along with the assurance of maintaining the property. Also, there is a power of sale clause in the agreement which means, in case the borrower is not able to pay the whole amount back, the trustee has the power to sell the property and pay the debt to the lender.
How to Draft a Collateral Trust Agreement
Drafting a collateral trust agreement includes the following steps:
- Choosing the type of property and lender: The borrower first needs to choose the type of property to be purchased. Following this, the borrower is required to choose a lender. The type of trustee thus involved also depends on the type of lender. If the lender is commercial, the trustee is generally chosen by the lender.
- Details for Collateral: The borrower is required to give proper details of the collateral and give insurance about the maintenance of the same.
- Signing the agreement: A legal contract including all the required information and terms is signed by the lender, the borrower, and the trustee.
- Receiving money: After all the legal formalities, the borrower is required to pay the installments timely.
Benefits of a Collateral Trust Agreement
Verbal promises are never reliable especially when it comes to lending a huge amount of money for the purchase of a property. In such cases, a written document is the best choice which includes all the details of the terms on which the parties agree. The various benefits of the collateral trust agreement are:
- There is a clear listing of the details of the agreed terms in the contract which are helpful at the time of conflict.
- The agreement gives the authority to the trustee of selling the property and clearing the debt in case the borrower is unable to pay the dues.
- The collateral trust agreement is more flexible as compared to other means of loans. Borrowers, who are unable to get loans through traditional means due to low credit score, can opt for private lenders.
If there is no agreement signed among the two parties, the borrower might stop paying the installments and the lender will have no proof against the borrower. As a result, the lender has to pay a large amount to the lawyers and struggle to claim his own money. The consequences might also include battling for ownership by both parties and the danger of personal safety and well being.
Types of Collateral Trust Agreements
- General agreement through collateral: The agreement can have a proper real estate property as a collateral.
- Trust bond agreement: In case the borrower does not have a proper real estate asset to mention in the agreement, he can use any financial asset including a stock or any bond. The most common collateral trust bonds example is that if a borrower agrees upon bonds or stocks as his asset, then the trustee has the right to sell the bond or stocks in case of default in payment.
Key Terms/Clauses in the Collateral Trust Agreement
The various agreement clauses included in the contract include:
- Covenants by the borrower who promises to own the property.
- Maintenance clause which means the borrower has to assure that he maintains the property.
- Power of sale clause which gives authority to the trustee to sell the property in case of default.
- Ownership transfer clause which states that the entire amount becomes due in case of ownership transfer by the borrower.
- Non-modification of senior mortgages by the borrower without the permission of the lender.
Here is the sample of the collateral trust letter. You can download the PDF and modify according to your needs.
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