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Contract For Deed

Because of recent credit tightening, some homebuyers may be less likely to qualify for mortgages than they were just a few years ago.

In a contract for deed, the purchase of property is financed by the seller rather than a third-party lender such as a commercial bank or credit union. The arrangement can benefit buyers and sellers by extending credit to homebuyers who would not otherwise qualify for a loan.

A contract for deed, also known as a "bond for deed," "land contract," or "installment land contract," is a transaction in which the seller finances the sale of his or her own property. The buyer finances the purchase with assistance from the seller, who retains a security in the property. In a contract for deed sale, the buyer agrees to pay the purchase price of the property in monthly installments. Under the terms of the contract for deed, the buyer is given possession of the property and equitable title to the property, often paying little or nothing down, while the seller holds legal title and continues to be primarily liable for payment of any underlying mortgage.The buyer has the right of occupancy and, in states like Minnesota, the right to claim a homestead property tax exemption. During the term of the contract for deed, the buyer may be required to keep the property insured and pay the real estate taxes, or reimburse the Seller for same. The buyer finances the purchase with assistance from the seller, who retains a security in the property. When the full purchase price has been paid including any interest, the seller is obligated to convey legal title to the property to the buyer.

The contract for deed document must meet the requirements for any contract and will also contain a lengthy statement of the rights and obligations of the parties, similar to those under a mortgage, including use of premises, risk of loss, maintenance of premises, payment of taxes and insurance, and remedies in case of default. Specific rights, such as acceleration or the right to prepay without penalty must be expressly written into the agreement. The contract is usually signed by both parties and acknowledged

As with other deeds, the contract for deed should also be recorded in the county Recorder's office. This should be done within four months after the signing of the contract, or else a penalty will be imposed on the principal amount on the buyer.

The contract for deed is a much faster and less costly transaction to execute than a traditional, purchase-money mortgage. In a typical contract for deed, there are no origination fees, no formal applications, and no high closing. Another important feature of a contract for deed is that seizure of the property in the event of a default is generally faster and less expensive than seizure in the case of a traditional mortgage. If the buyer defaults on payments in a typical contract for deed, the seller may cancel the contract, resume possession of the property, and keep previous installments paid by the buyer as liquidated damages. Under these circumstances, the seller can reclaim the property without a foreclosure sale or judicial action

Because the buyer in a contract for deed does not have the same safeguards as those afforded a mortgagor in a purchase-money mortgage, the contract for deed may appear to be essentially a rent-to-own arrangement. However, in a typical contract for deed, the buyer becomes responsible for the obligations of a mortgagor in possession, such as maintaining the property and paying property taxes and casualty insurance. In addition, unless prohibited by the contract, either party may sell his or her interest in the contract.

Homebuyers may be attracted to a contract for deed purchase for several reasons. This method may be especially appealing to homebuyers who do not qualify for a mortgage, such as people who work jobs with hard to prove income and are therefore unable to prove their ability to make payments. First-time homebuyers who lack experience in the market or individuals who are wary of traditional financial organizations may also choose a contract for deed because of the relative simplicity of the buying process.

WHAT ARE THE RISKS?

Whether you are the buyer or the seller, there are numerous risks involved with a contract for deed.

Buyers Risks:

  • The buyer has no equity in the home until it is fully paid off. This means that even if you make payments religiously and on time for several years, but if you fall on hard times and fail to make a couple of payments, you could lose the house and all of the money you paid to the seller.

  • However, there is also a risk to the buyer because of the fact that the seller holds the title. If there is a default on the contract, the buyer risks everything, including all that he has previously paid.

  • One major risk stems from the short time period required to cancel the contract in the event of default. For example, in Minnesota, when a buyer falls behind on payments, the seller can file a Notice of Cancellation of Contract for Deed with the county and serve the buyer with the notice. The buyer has only 60 days from the date of the filing to address the items of default and pay the allowable attorney fees to "reinstate" the contract. This is a short time span in comparison to the six months or more afforded mortgagors who face foreclosure. As a result, a defaulting contract for deed buyer has a much narrower window of time to find a new home and is likely to have limited housing options.

  • Another major risk for the buyer is the balloon payment. Unlike most traditional mortgages, the majority of contracts for deed are not fully amortized. Instead, the contract is most frequently structured to require monthly payments for a few years, followed by a "balloon payment" that completes payment on the house. To make this balloon payment, the buyer will almost inevitably need to obtain a traditional mortgage. If a buyer is unable to qualify for a mortgage at the time the balloon payment is due, he or she is likely to face cancellation of the contract.

  • The Buyer must be cautious when entering into a Contract for Deed to ensure that the Seller is the actual owner of the property and has authority to sell the property. The Buyer can contact the County Recorder for the county the property is located in to check the property records.

  • Another risk for contract for deed buyers stems from the fact that the seller retains the title to the property during the life of the contract. Since the seller retains the title, he or she 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 and it is time to deliver the title. He or she does not need to have good title at the time the contract is executed nor during the life of the contract. Depending on state law and whether the contract is recorded in a timely manner, the buyer's interest may be junior in priority to these pre- and post-contract encumbrances placed on the property by the seller.

  • In addition to the problems described above, no two contracts for deed are alike and the terms of the agreement are often unclear. The contract for deed is typically a one- to five-page document that includes the amount of the purchase, the interest rate, the monthly payment, and some verbiage regarding cancellation. The documents often do not include a standard arrangement for beginning the cancellation process. This lack of clarity in contracts for deed creates difficulties for financial counselors who give advice to buyers facing forfeiture.

Sellers Risks:

  • One obvious risk is that the buyer in a contract for sale transaction is typically someone who could not qualify for a conventional loan. There are all kinds of reasons why a buyer would not qualify for a loan (poor credit scores, little or no income, high debt, etc.), but they all mean that there is a pretty good risk that the buyer could default at some point.

  • If the buyer defaults, the process of clearing record title may be time-consuming and costly, especially if the buyer is under a legal disability, is bankrupt, is a nonresident, or has created encumbrances in favor of persons who might have to be joined in any quiet title action.

  • The seller's interest in the contract for deed is less salable than a mortgagee's interest would have been had the seller sold under a purchase-money mortgage.

  • Seller who chooses this remedy is rescinding the contract and cannot seek a deficiency judgment for the unpaid balance.

Benefits accruing to the Buyer (Vendee):

  • Speed and Simplicity - this method of acquiring a home generally can be accomplished even with the help of a Title and Escrow Company within days instead of weeks and months.

  • A contract for deed comes very useful to prospective buyers who may not qualify for a loan with the bank, such as those with bad credit ratings.

  • Buyer typically can purchase with a lower than typical down payment.

  • If seller is motivated they may be able to negotiate a lower than market price.

  • Buyer, if a rehabber or wealth builder may be able to negotiate a provision for assignment of the Contract to another Buyer at a significant profit.

  • If using the Contract to rezone, improve, remodel the property, the added value can accrue to the Buyer.

  • Buyer may be able to "Homestead" the home.

Benefits to the Seller (Vendor) may include:

  • A ready prospective buyer willing and able to provide upfront cash flow and to make or assist in paying the existing mortgage payment.

  • Pay all or part of the cost of ownership including taxes and insurance.

  • Take care of the maintenance and upkeep of the property.

  • Reduces the risk of owning a vacant property subject to vandalism and falling into disrepair.

  • If the buyer/vendee fails to make the payments as outlined in a legally prepared Contract for Deed the Seller can sue for strict foreclosure and may have the right to repossess the property without a long protracted and expensive foreclosure process.

Advice from the experts

While a contract for deed may have its appeal as an alternative financing, given the risks involved, buyers and sellers should proceed with caution when entering such an arrangement in the private market. The following advice from the Minnesota Legal Services Coalition stresses that both parties should make an effort to be fully informed.

First and foremost, the seller must set forth the terms of the contract in a purchase agreement. It is important that both parties fully understand the provisions of the contract, because once the purchase agreement has been signed, the options available to both the seller and buyer are limited.

The buyer should know whether he or she is responsible for property tax payments and insurance and whether the contract for deed includes a balloon payment. If it does include one, the buyer should be certain that he or she would be eligible for a mortgage to cover the payment when it comes due.

The buyer should also make sure that the seller is the true owner of the house by checking with the county recorder's office to see who is listed as the registered owner. If the seller still has a mortgage encumbering the property or is responsible for paying the taxes or insurance, the buyer should contact the seller's mortgage company prior to signing the contract to determine whether the seller is current on his or her payments. Some "scam" sellers will retain a buyer's payments and not apply them to the mortgage. If the seller defaults on the mortgage in this scenario and the home is foreclosed, the buyer will lose the house and all the paid installments.

The buyer should ask the seller for a Truth in Sale of Housing report to determine the condition of the house. This report is required in Minneapolis and St. Paul and some other cities. In cities where it is not required, the buyer should find his or her own inspector to assess the condition of the home.

Finally, once the contract for deed is executed, the buyer should record the contract immediately with the county recorder's office or the registrar of titles. While statutes requiring this registration are rarely enforced, recording the contract will help prove the buyer's possession of the property and protect him or her from post-contract encumbrances placed on the property by the seller.

We have experienced realtors to answer any questions and assist you in purchasing or selling a home on a contract for deed.

Contact Swift Realty today.

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