What is a Contract for Deed?

If you’ve been turned down for a home loan from a traditional mortgage lender, don’t despair. You have options, and one of them may be a contract for deed. Also known as an installment agreement or land contract, a contract for deed involves seller financing for the property. If you see a home sale ad offering owner financing, it’s likely the seller has a contract for deed sale in mind. Another advantage – the buyer and the seller may structure the agreement in a mutually agreeable fashion.

How a Contract for Deed Works

A contract for deed is not one-size-fits-all. It is an agreement tailored to the individual needs of the buyer and seller, and offers great flexibility. The contract for deed terms, negotiated by both parties, includes the down payment, interest rates, amount of monthly house payments and how property taxes and insurance are paid.

The seller holds title to the property until the balance is paid. At that point, the seller transfers legal title to the buyer. Should the buyer default, the seller may repossess the property. Depending on state law, the seller may have to reimburse the buyer for improvements made to the property should repossession occur.

Keep in mind that laws for contract for deeds vary by state, so it is critical to find out how they are treated in the state in which the property is located. In some states, the contract of deed must be registered with the county recorder within a specific period, while in other states no such formal recording is necessary.

Contract for Deed Advantages  

For a buyer who cannot obtain a traditional mortgage loan, a contact for deed offers them the ability to buy a property. In addition, a contract for deed arrangement generally moves much more quickly than the mortgage process.

A contract for deed doesn’t involve many of the expenses of a traditional mortgage, including closing costs and loan origination fees.  While a contract for deed doesn’t require appraisal or home inspection, as does a traditional mortgage, it is a good idea for the buyer to pay for these items. You don’t want to find out the house is worth far less than you agreed to pay or that it has serious structural defects.

The buyer can negotiate a down payment with the seller, which may prove far less than the usual 20 percent of the home’s cost and won’t involve costly private mortgage insurance. If there is a reason a potential buyer doesn’t want to reveal their financial records to a lender, that’s another reason to consider a contract for deed.

For sellers, one advantage of using a contract for deed is that, should the buyer default, there is no long, drawn-out foreclosure process. The contract is terminated, and the seller gets their property back.

Contract for Deed Disadvantages

Unlike a traditional mortgage, a contract for deed is seldom in place for long periods, as is the case with the typical 30-year mortgage. On average, the length of a contact for deed is five years, although the seller and buyer can agree to any term length. The average contract for deed ends in a balloon payment at the end of the term.

A major contract for deed disadvantage is that equity is not built up in the property as the buyer makes payments, so if they default, they have lost any funds contributed to the home purchase. There’s also the question of title. A standard mortgage requires clear title to the property before the lender will approve the loan. That’s not the case with a contract for deed, unless the buyer insists, which is a wise idea. Otherwise, when that last payment is finally made and the buyer thinks they own the dwelling, it could turn out that the property’s title is murky. Since the seller owns the property up to that final payment, they could also incur liens on the property that affect the title. For example, if the seller doesn’t pay his federal income taxes, the IRS may put a lien on the property. Since the seller still owns the home, they are able to take out a home equity loan on the property, and that is also a lien. That could mean the buyer is out of luck when it comes to obtaining the title.

For the seller, the biggest disadvantage of a contract for deed is that they will not receive all of their funds until the end of the contract. With a traditional mortgage, they receive the funds for the sale at closing.

Contract for Deed Considerations

If you cannot obtain a traditional mortgage, a contract for deed is a viable option. If you can qualify for a mortgage, that’s probably a better route. Even though the contract for deed sports various advantages, there are few, if any, protections for the buyer, which is not the case with a mortgage.