A Contract for Deed vs. Traditional Mortgage

Inability to get financing for a home does not always mean that someone does not have the financial means to pay for the home. This is also a way of extending credit to those who might not otherwise 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. Rather than having third-party lenders financing the purchase of a home, the seller finances the purchase in a contract for deed.

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 with no down payment. 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 interest in the property.

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 simplicity and speed of this type of deed certainly attract people to it, but it creates risks for both the seller and the buyer. 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 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. 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 structured so that the buyer makes monthly payments for a few years, followed by a balloon payment that covers the remaining balance due. In order to afford this payment, the buyer might need to consider taking out a mortgage. Many buyers hope to improve their credit while making monthly payments under a contract for deed, but this only works if the seller reports the payments to a credit agency.

A seller can execute a contract for deed with limited disclosure about the conditions of the property. In a third-party-financed sale, lenders must follow 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 maintain good title.

Buyers should be aware of the risks and take appropriate steps to safeguard their investments. Clarify who is responsible for property tax payments and insurance. Additionally, notice if there is a balloon payment figured into the terms of the contract and plan accordingly. Finally, 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 contract for deed can be a very effective tool for people who cannot qualify or choose not to apply for a traditional mortgage.

Please contact an attorney with questions about contracts for deeds and traditional mortgages.