The contract of deed is entered into as one of the ways to finance a house. Through this approach, the seller of the house becomes the financier for the house. After the buyer has completed all the payment for the house, both parties then enter into the deed. Buyers often prefer this method of financing when they do not meet the requirements for other more conventional house financing approaches.
A contract for deed is often referred to as either a contract for sale or a land contract.
Table of Contents
- Introduction to Contract for Deed
- Ultimate Guide to Contract for Deeds
- Seller Considerations for Contract Deeds
- Historical Context and Concerns
Introduction to Contract for Deed
A contract for deed, which is also referred to as either a contract for sale or land contract, is a type of financing method used by a buyer who does not hold eligible to access a mortgage loan. Within this deed, the seller acts as the financier of the property in a manner similar to a mortgage company would act in a conventional financing method.
The seller here offers to fulfill all the financing needs of the buyer for the pertinent property. The seller, as the financier holds the legal rights as the owner of the property whereas the buyer establishes an equitable title. As soon as the full payments have been reached, the buyer is provided with the deed to the property.
The contract for Deed vs. a Mortgage
Both of these methods are a way to home financing, or to build partial equity in the property. Both of the options also include similar exemptions and tax benefits. One of the main differences between the two is that in case of a Contract for Deeds the buyer is not eligible for a legal title of ownership or possession of the deed until he has fulfilled all the due payments.
This varies with state laws, but some jurisdictions may grant sellers the right to include any contractual terms that make it permissible to foreclose in case of any defaults such as the buyer fails to make the agreed monthly payments.
The contract for Deed vs. Renting
The renting tenants do not hold possession of their dwellings. This means they are not liable to any home maintenance or repair expenses and may avail the option to move somewhere else as their renting agreement terminates. But the renting individuals also do not get the chance to build equity in the property that they are renting, unlike homeowners. However, renting individuals are able to shield themselves from risks such as an underwater mortgage in case there is a real estate bubble similar to the one from 2008.
Ultimate Guide to Contract for Deeds
A contract of deed is a formal agreement for the possession of property or land. Typically, they are considered a risky and uncertain agreement. The risks can become more highlighted when compared to traditional mortgage terms. There is a possibility of mutual or individual gain through a contract of the deed but this will be subject to a number of factors. It may be a preferable option for individuals who are not eligible for a conventional mortgage either due to a bad credit score or any other reasons.
This is a guide encompassing all the ins and outs of these purchase agreements, such as their detailed introduction, what they comprise, their potential advantages and disadvantages, comparison to other conventional agreements, how they are applicable to farmers and many other details. After going through this, you will be able to deduce whether they are the right option for you.
#2 Wrap Around Contract for Deeds
Sellers may also earn additional income through overrides.
As the contract for deeds is entered due to the ineligibility of the buyer to access a mortgage, contact for deeds is also entered through loopholes. In such a case, the financing seller may prove eligible and hence get a mortgage on the house. Through this process, the buyer keeps making monthly installments to the mortgage holder and the seller, in turn, utilizes these installments to make further mortgage payments. The seller gets to keep a profit on this.
The financing seller can also yield profits through overrides. This is when the interest on the wrap mortgage agreement is higher than what the seller pays in mortgage interest. The seller gets to keep the difference.
What’s Included in a Contract for Deed?
It is recommended that a contract for deed includes:
- Purchase price
- Down payment
- Interest rate
- Number of monthly installments
- Responsibilities of the buyer and seller
- Legal remedies for the seller if the buyer does not make payments
Pros and Cons of Contract for Deeds
As mentioned earlier that they are entered into due to ineligibility, they can prove very risky. Still, benefits can be expected such as:
- It offers higher income levels regularly due to higher interest rates than offered by other investments, such as deposit certificates.
- You are released from the monthly expenses incurred through the property.
- You can utilize the profit gained to pay off any previous debt.
- Property that can not be sold within the typical estate market because of any incongruencies with the standards or violates a code can be conveniently sold through this method.
- Eliminates any costs related to searching for a suitable buyer in the conventional real estate market.
- Will make the property a more attractive option than other rival properties enabling it to be sold faster.
- You can enter into the homeownership process even if you are considered ineligible by other financiers such as banks, credit unions or lenders.
- The seller may still be interested in reviewing your credit report first.
- The terms of the contract may be more flexible: there is room for negotiation regarding lower down payment, length of installments, how frequently you pay the installments and the level of interest rates charged, etc.
- It offers a relatively faster and low-cost closing process.
Seller Considerations for Contract Deeds
As advised earlier, contracts for deeds can be a risky and uncertain financial agreement for sellers. Due to this, you as a seller should be well-informed about how to shield yourself against any risks. That requires conducting the following:
#1 Reviewing the buyer’s credit report.
Ensure that you have screened the report for any factors that may prove problematic in the future such as any previous bankruptcy, or if he has been evicted before, foreclosure sales or any history of bad debt.
#2 Set a higher down payment requirement
When the house deposit is larger, there is less possibility that the buyer will refuse to make further payments.
#3 Ensure financial check
Fully ensure that the prospective buyer is employed in a secure job and has the capability to make future payments.
#4. Background check
Run a background check and include references from their former landlords to inquire about their attitudes and behaviors regarding rent payments.
#5 Consider short-term financing.
A number of ways to do this are by requiring a lump sum payment after every certain length of period, even if the length of the payment is more gradual than it.
Buyer Considerations for Contract Deeds
Contracts for deeds can also be risky for buyers because these contracts often come with higher interest. Here are other things to consider:
Contracts for deeds can prove risky for both parties, including the buyer, mainly because these agreements demand higher interest rates to be paid and they generally cost more in the end. Here are a few aspects to factor in:
- When do you, as a buyer, gain complete ownership?
The duration that the buyer is making regular payments, he holds the equitable title which means that they have a stake in the house. The seller does not own the right to sell the house to another individual.
After the last payment has been made, all the legal titles of ownership are consigned to the buyer given that all terms of the agreement have been fulfilled. In order to consign the legal title, it is imperative that the deed is filed with a competent and applicable government office and accurately name the new owner of the property.
- What happens in case the buyer fails to make the payments?
In case the buyer is not in the position to make the agreed payments, the seller is eligible for a “Land Contract forfeiture” filing. Under this action, the buyer loses all the money that has been paid previously and also lose their built equity and the title.
As a Seller, How Do I Find a Buyer?
If you plan on selling through this method, below is our guide to understanding the process better:
- Make prospective buyers aware of your offering by mentioning “Financing available” on your advertisements.
- As a buyer, you may inquire the seller about their willingness to offer any flexible financing options.
The contract for Deed for Farmers
Typically both the contract of deeds and mortgage loan options are availed by farmers to buy agricultural land. In case a farmer is only beginning their farming, a contract of deeds may be a more preferable option due to its convenience, low eligibility criteria and low costs compared to having to become eligible for a mortgage loan.
Additionally, the required down payments and interest rates to be paid are typically also lower than the mortgage option. Also in a contract of deeds, the buyer is not to pay additional fees such as application fees, origination fees, and other pertinent fees charged by agents or other lenders.
Benefits of Selling a Farm with a Contract for Deed:
- Selling their land through a contract of deeds provides tax benefits as well, as the income made through the sale is amortized and not received as a lump sum.
- It is also a convenient way to help someone else enter into the business of farming especially if a relative or a family friend is new to the field and wants to own farmland. It is also a less complicated method than conventional sales in the standard market as there is no need to hire a real estate agent, and neither any formal appraisals or mortgage approvals are needed.
Historical Context and Concerns on Contract of Deed:
Similar to the previous cases in American housing, the contracts for deeds have also many cases of racial inequality and discrimination. Since the beginning of 1930 to 1960, the federal mortgage insurance did not recognize the black people as eligible applicants for their services and in response could not prove their eligibility for a conventional loan.
This lead to a black market where real estate investors mainly sold their property to black individuals but with a contract deed of a highly prolonged amortization period often of 20-40 years long. These contracts also incorporated very high-interest rates and also had strict terms related to “land contract failure” where the black people would forfeit all off their money even if one payment was made late. This caused major financial harm to black people rather than serving as a convenient approach to homeownership.