A contract for deed, sometimes known as a land contract or an installment sale agreement, is a contract between a seller and buyer of real property in which the buyer agrees to pay the purchase price of the property in monthly installments. The buyer can take immediate possession of the property, often without having to put anything down. The seller retains the legal title to the property until the payment terms have been fulfilled. The buyer has the right of occupancy and the seller retains a security in the property.
The simplicity and speed of this type of deed certainly draws people to it, but it does create risks for both the seller and the buyer. Recent times have left many people unable to qualify for the mortgages they may have been able to get just a few years ago. Because of this, potential homebuyers are looking for alternatives. Not being able to get financing for a home does not always mean that someone does not have the financial means to pay for the home. Building good credit is an important step in buying a home, and the contract for deed can be an effective tool to help with this step.
Rather than having third-party lenders financing the purchase of a home, the contract for deed instead has the seller financing the purchase. This is also a way of extending credit to those who might not be able to qualify for a loan. In fact, various housing advocacy organizations have used this as a way to help low- to moderate income families achieve homeownership. In a contract for deed, there are no origination fees, application costs, or high closing costs to deal with. Generally, the IRS considers a contract for deed to be a sale, which means that buyers can deduct interest payments the same as they would for mortgage payment. If property attained through a contract for deed is ever seized, this process is generally faster and less expensive than seizure under a traditional mortgage. If a buyer defaults on payments or violates the terms of the contract, the seller can cancel the contract and keep any previous installment payments from the buyer as liquidated damages.
The contract for deed, as an alternative to a mortgage, only offers very limited protection to a buyer. While not yet having full ownership rights of the property, the buyer is still required to make repairs, pay taxes, and keep up with their monthly payments. Some people see this contract as a glorified ‘rent to own’ type of agreement. During the life of the contract, the seller still has rights to the title. In the event that the buyer misses a payment, the seller can file a notice of cancellation of contract for deed and then give the buyer the notice. After this, the buyer has sixty days from the date of filing to address the default terms. A traditional mortgage will usually offer the buyer at least six months. Even though the process of seizure is less expensive in a contract for deed than it is in a mortgage, the buyer is left with fewer options.
Contracts for deeds are usually formatted so that the buyer makes monthly payments for a few years, followed by a ‘balloon payment’ that completed the payment. In order to afford this payment, the buyer might have to consider taking out a mortgage, which is of course what they tried to initially avoid by signing a contract for deed. Many buyers hope that they will be able to build up their credit while making monthly payments. However, this only works if the seller reports to a credit agency. This is not a typical occurrence. Additionally, buyers sometimes hold out hope that a lender will take their contract for deed and the evidence of on time monthly payments as proof of their credit, but lenders are not required to do this.
A seller can execute a contract for deed with limited disclosure about the conditions of the property. In a third-party financed sale, lenders have strict requirements for title examination, title insurance, and appraisal, which provide the collateral damage of disclosure for the buyer. In a contract for deed, buyers should be aware of the need for appraisal and title examination.
Since the seller maintains title of the property during the life of the contract, the seller may continue to encumber the property with mortgages and liens. The seller is only obligated to convey good title when the purchase price is fully paid. During the life of the contract, as well as when the contract is executed, the seller does not have to have good title.
Buyers should be aware of the risks and should take appropriate steps to safeguard their investments. When the contract is executed, the buyer should know whether he/she is responsible for property tax payments and insurance. Additionally, if there is a balloon payment figured into the terms of the contract, the buyer should be aware of this in order to plan accordingly. Before signing a contract for deed, the buyer should go to the County Recorder where the property is located to make sure that the seller is indeed the owner of the property. If there is still a mortgage encumbering the property, the buyer should contact the mortgage company prior to signing to determine if the seller is current on the payments. The buyer should also have the condition of the home assessed prior to signing.
The contract for deed can be a very effective tool for people who cannot qualify for a traditional mortgage. If used correctly and wisely, the interest terms are often better than those of mortgages. It is in a buyer’s best interest to look into all details of the contract for deed agreement.