We’ve noticed, and maybe you have, too. Mortgage lenders have really been tightening their loan approval standards these days. Lenders are cautious because so many people are coping with layoffs, career changes, and volatile financial situations.
Some sellers are willing to help hopeful home buyers avoid the mortgage process, using the contract for deed. Often, these instruments are put to use when the seller has a family member or close friend who’d like to own, but has a non-traditional job or financial situation.
Also known as an installment sale agreement, a contract for deed is a home purchase — it’s just financed by the seller, not a financial institution. After the parties close on the agreement, the buyer lives in the house as the owner, and sends the seller monthly installments. The length of the loan and the installment amounts are negotiable. There might be no down payment, or a relatively modest one.
A contract for deed is a quick way to bypass the loan application process and sell a house, while enjoying an income stream as the buyer sends in monthly payments. Payments made through the term of the contract belong to the seller, much as rental payments would be.
The contract is easy to end if necessary. As the seller, you’ll still be holding your title in the unfortunate event of a buyer breach or default. No need for a foreclosure. Should you ever need to reclaim the property, the process is simpler and faster than the seizure of a home from under a mortgage. Some sellers have buyers sign a quitclaim along with the contract for deed, just in case any future question about ownership should arise. If the seller records the quitclaim, any claim the buyer might have on the property is straightforwardly extinguished.
The downsides? You’ll hold the title, and this is a double-edged sword. You could be held responsible for any code violations or neglect on the part of the buyer. You’ll also be waiting for some time to be fully paid for the house.
Of course, if there is a mortgage on the home, your name’s still on it, and you’ll continue to be responsible for paying it through the contract’s term of years.
Pro tip: Rules pertaining to contract for deed forms are state- and county-specific. Know and follow your law. In some states, the seller must register the instrument with the county recorder of deeds within several months or face a fine. The seller should use IRS Form 6252 for reporting a sale by a contract for deed — and thereafter, every year that the seller takes income from the buyer.
For the right buyer and seller, the contract for deed is a good alternative home sale method. It offers a way for people to handle a transaction together without agents and banks in the mix. It can also give the buyer with a less-than-stellar credit score time to get on better footing to get a mortgage in the future. For buyers who hit walls with mortgage companies, a contract for deed can work, although it lacks certain protections for the buyer. With a traditional real estate purchase, there’s the inspection, the appraisal, and a title search. These steps are vital safeguards for the buyer. Get your seller’s agreement that they’ll be performed in your contract for deed.
A couple of words to the wise. As the buyer, you will not receive the title before paying all the installments required in the contract. If you’re buying a home this way and want to do home improvements before you’ve paid in full, you’re taking a risk that you could lose the money you invest. Also, unless the contract is properly filed with the county recorder of deeds, the owner could saddle the house with mortgages or other secured loans.
Before signing a contract for deed, study the terms, the costs, risks and responsibilities. The terms usually hold the buyer responsible for paying for homeowner’s insurance. A buyer may also have to deal with repairs and weather damage costs, routine maintenance and landscaping. The buyer may also be paying the property taxes.
Under your state law, it’s possible that if you can’t pay or otherwise adhere to the terms, investors may begin an eviction as early as two months from the time of default. (See Minnesota’s “Cancellation of Contract for Deed” form here (PDF). If you believe you have a countervailing claim, you’ll have to go to court to try to protect your interests.
Obviously, it’s better to successfully manage the payments and all the costs involved. But have a backup plan in case, at any point, you can’t. How many days do you have to leave the home in the event that you cannot keep up your payments? These contracts tend to require a lump-sum or “balloon” payoff in a few years. Is your plan to apply for a traditional mortgage by then? Get your credit score in shape for the application process well in advance!
Pro tip: You might be able to sell your interest in the contract for deed, unless the terms forbid it.
There are reputable groups out there that use the contract for deed model. Some help struggling people get on track to homeownership — like this group, whose stated purpose is to obtain property and remove it from “the speculative, for-profit, real estate market.” Collaborating with nonprofit entities, homeowner assistance groups may use the contract for deed as one method of helping people of limited means.
Now, what about the for-profit market? Proceed with caution, and the knowledge that a contract for deed lacks many of the formalities and protections supplied through the conventional sale process. Research the company. Watch for people who take the buyers’ installment payments but don’t pay mortgages on the homes. Scam sellers deliberately fail to pay mortgages, so the homes go into foreclosure, and the buyers lose their homes and all the money they paid into them by that point.
There are plenty of less extreme but still troubling abuses. In June 2020, the Consumer Financial Protection Bureau settled a case against several companies that collected foreclosed homes and sold them using the contract for deed model. When buyers questioned the inaccurate details that started appearing in their credit reports, the companies refused to investigate or help.
In some areas, investors use contract for deed sales to get around landlord-tenant law. Cities and even states have confronted this, and acted to protect buyers in various ways. For example:
Both seller and buyer must know exactly what’s in the contract and why, and the seller should clearly set forth the contract’s terms in the parties’ purchase agreement. The importance of understanding the contract’s terms and the law that controls them cannot be overstated. Once the parties sign off on the purchase agreement, they are bound by the contract’s terms, and the applicable state and county rules.
The information in this column is not intended as legal advice, but as an introduction to the contract for deed as well as what to watch out for. If you have a legal problem or questions about using a contract for deed, consult a real estate attorney in your state for advice that takes into account your own particular situation.
Photo credit: Jay Haych, via Unsplash.
