Buyer Can’t Get a Mortgage. Seller Will Take Installment Payments. A Win-Win?

In a “contract for deed” or installment contract, a seller provides financing directly to the buyer. No mortgage company is involved.

The harder a mortgage approval is to get, the more attractive this alternative becomes.

It can be a lifeline for people with varying income or a thin credit profile. It can also be a nightmare. Avoid that last type. Read on to learn more.

As With an Immediate Sale, There Can Be Advantages for Both Sides.

What does the buyer get? A path to home ownership. Costs and expectations can be easy to handle. These loans are usually meant to be paid off in just a few years. The buyer gets terms that are generally unavailable from a standard lending company.

And the seller, by financing the property transfer, gets a regular income stream. That income source will exist until the buyer finishes paying for the home in full. Some sellers use the method as a way to spread taxable profits out over a period of five years, or however long the contract spans.

The Buyer Must Wait Longer for the Deed—But Builds Equity in the Meantime.

During the repayment term, the buyer doesn’t hold the deed. The buyer holds equitable title until the repayment term is successfully finished.

The buyer may live in the home, and do upkeep and renovations. Although there’s a wait for the deed, the buyer is able to build equity while paying the debt off.

A Contract for Deed Arrangement Helps a Buyer With Unconventional Income Sources.

Lenders like W2 forms. Independent workers don’t have those. But that shouldn’t lock potential applicants out of the mortgage world. Underwriters can be too strict for small business owners and contract workers who are perfectly capable and willing to repay a mortgage.

This is why contracts for deed (installment contracts) are handy for quite a few buyers. With contracts for deed, sellers accept a range of proof of ability to pay back debt.

Clearly these agreements are filling a major need. Hundreds of thousands of U.S. homes currently use this kind of financing. And a Pew Charitable Trust Survey found 87% of respondents who have (or have had) a contract for deed feel positively about it.   

The Buyer Must Understand the Terms—And Be Prepared to Meet Them.

Generally, the seller is in control of setting the terms, but negotiation factors into them.

The seller and buyer can work out the total price, payment timetable, the interest rate, and consequences for default.  They can also determine the down payment and the interest to be paid on the debt.

Once signed by the buyer, the contract is binding. Its terms must be followed. Otherwise, the buyer can face forfeiture (in most states). No, that’s not the same as foreclosure. We’ll return to this momentarily.

Contracts for Deed Are Not Unusual in Some States.

These contracts have been normalized in some midwestern states, like Minnesota, Michigan, and Ohio. About half the U.S. states have laws in place to regulate installment home purchases. In the states that have legal provisions governing contracts for deed, sellers can be held to account for vague or misleading contracts. This helps keep a buyer from taking on too much risk.

Some states have well established laws that mandate clear, written contracts stating the purchase price, interest rate, how home improvements will be accounted for and who pays for them. The contracts should also include the repayment schedule, provision for late fees, and consequences for a borrower who falls behind. A state that calls for key factors to be laid out in writing helps the buyer understand the deal.

Buyers Should Be Sure They Know What They’re Getting.

Buyers should know the value of a title search. (Don’t forget the municipal lien search, too.) Title companies offer the standard professional service to be sure the title is free and clear.

What if the seller didn’t finish paying a contractor, for example? What if work was done on the home without the necessary permits? Companies or governments can record liens and fines on the property that can end up stuck to the title.  

Therefore, hiring a title company to do a title search really is important. So is hiring a professional appraiser. Looking up the home’s value on a real estate website is not a reliable way to value the property.

Installment Contract Buyers Should Get It (All) in Writing.

Buyers can negotiate on payment amounts, interest, and terms. But put them in writing, to avoid future disputes. Avoid any financing with balloon payments. Do not assume other financing to cover the balloon payment will be available when the time comes.

What “extra” costs does the seller expect the borrower to cover? The written agreement should say who pays the property taxes and insurance premiums. Does a borrower lose everything they paid into the deal if they don’t make it to the final payoff? Buyers should know the answers. And they should check the applicable laws, to be sure their contracts are fair and legal.

Default May Lead to the Forfeit of the Home.

Remember that the seller is keeping the title in most cases during the term of the contract. This puts a buyer’s investment at risk in case of harmful decisions by the seller. For instance, the seller’s activities can result in judgments or liens being placed on the home.

Need we say it’s a good idea to consult a real estate attorney or financial expert before signing?

Forfeiture Is Not Foreclosure.

Contracts for deed may include eviction rules in their consequences for nonpayment. If so, the borrower could forfeit the right to their investment and equity.

Have an attorney look over the contract. The attorney should check it against state law for the rules about forfeiture—notification and other provisions. The attorney should check federal law, too, and be sure the agreement is in compliance.

Federal rules for installment contracts have recently been established. They are important. They cover key matters like mandatory disclosures, and grace periods for backing out of deals when buyer’s remorse strikes.

Buyer, Don’t Just Beware. Get an Inspection.

Some contracts for deed involve fixer-uppers and the parties understand this.

Unfortunately, the custom has been abused in some cases. Don’t be the buyer who buys a fixer-upper by accident. Homes in disrepair can put your health and safety at risk. They might also violate local ordinances.

Important notes: Buyers may be able to deduct interest in some situations. Consult a tax professional for guidance specific to your situation. If you believe you’ve been taken in a predatory contract, contact local law enforcement and your state’s attorney general.