A “contract for deed” agreement is a type of legal document that permits a person who is buying a house to make monthly installment payments to the seller until the property is paid off in full. These agreements can be useful for homebuyers who either do not qualify for standard loans or need a quick way to pay for property.
Contract for deed agreements, also commonly referred to as “installment agreements” or “land contracts”, are less costly and much faster than using a mortgage to finance a home. In fact, the homebuyer can skip the mortgage and loan process altogether, avoiding fees and long application processes.
Basically, how contract for deed financing works is that the homebuyer will enter directly into a contract with the seller in which the seller will agree to provide financing to the buyer for the property. In other words, the seller is financing the sale of their own house.
Why Might a Seller Enter into a Contract for Deed?
The exact terms of a contract for deed agreement are flexible and may depend on what the parties negotiate when creating the agreement. Generally speaking, however, the majority of these agreements only last for three to five years; with five years being the most standard length.
Some other typical contract for deed terms may include:
- A down payment amount (normally a certain percentage based on the current annual market rate);
- How often the seller is paid (usually in monthly installments);
- The set amount for installments (includes the combined principal sum and interest fees);
- Whether the buyer or seller is responsible for mortgage insurance fees and property taxes;
- A “due on sale” clause and/or balloon payment conditions;
- The length of the contract (i.e., start and end date); and
- Various other terms that the buyer and seller determine are important for the contract.
What Are the Advantages and Disadvantages of a Contract for Deed?
As with any contract that involves financial risk, there are several benefits and drawbacks to contract for deed agreements. The following is a list that contains some of these benefits and drawbacks, which includes:
- Contract for Deed Advantages:
- Financing options: Issues, such as high interest rates, bad credit, and inability to qualify for other reasons can make getting a loan or mortgage very difficult. A contract for deed can bypass all of this and the buyer can negotiate with the seller for a lower or more flexible down payment and interest rates.
- Accelerated closing: As mentioned, contract for deed agreements allow buyers to avoid waiting for the loan or mortgage process, and to finance the property directly from the seller. Thus, they can obtain possession of the property faster than if they had to wait for things like bank loans or mortgage applications to be complete. The contract permits the buyer to take possession of the property immediately.
- Negotiable terms: Negotiating can be both an advantage and disadvantage in this case. As stated above, this option can be helpful for buyers who do not or cannot qualify for loans and mortgages. Also, the buyer may not have to pay extra for missed payments, so long as terms of the contract do not require it. Again, unlike strict bank regulations, the seller and buyer can contract for the terms they want.
- Others: Other benefits can depend on what the parties include in their contract terms, but generally the buyer may enjoy faster and less costly transactions, and more time to save up for any balloon payments. As for the seller, they can choose from a wider selection of buyers, can avoid the foreclosure process with the contract, and the buyer will be responsible for the appraisal and costs.
- Contract for Deed Disadvantages:
- Higher payments: Since a contract for deed permits a buyer to avoid the process of obtaining a loan or mortgage and go directly to the seller for financing, the seller may charge a higher purchase price for the home or require a high down payment. Additionally, while the parties are free to negotiate the terms of their contract, the seller may also demand higher interest rates or a fine in the event of a default.
- Transfer of deed restrictions: While the buyer takes possession of the property, the seller holds on to the title (i.e., legal possession) of it until the buyer pays in full. Thus, the buyer cannot sell or transfer the property because they do not hold title.
- Non-negotiable terms: The seller has the upper hand when it comes to negotiating contract terms. This is because not only do they own the sale property, but they are also the party financing the sale. Though the parties are free to negotiate their own terms, the seller needs to make sure they are protected if the buyer defaults. All of these reasons can make negotiating difficult for the buyer.
What’s the Difference Between Contract for Deed and Rent to Own?
As previously mentioned, a contract for deed is an agreement in which the buyer pays a set amount of monthly installments to the seller until the property is paid in full. After the final payment, the seller will give the buyer legal title to the house. This means that the buyer now has both possession and legal rights, making them the true owner of the house.
On the other hand, a rent to own contract is when a person signs an agreement to rent a house or condo that includes the option to buy the property when the lease expires. The monthly rent payments that the person makes will go towards the purchase price of the house.
For a buyer, a rent to own contract may be useful for building up a better credit score, and having the option to either purchase or continue renting the house without having to make a decision right away. It also gives buyers the benefit of putting their rent money towards a good cause: the price to buy the property.
A contract for deed, however, may be a better option for buyers who want to already possess the house they are living in, would prefer lower monthly payments, and do not qualify for a mortgage or loan. This last piece of information is particularly important because oftentimes rent to own contracts require the buyer to mortgage the property if they cannot purchase it outright.
Who Pays Property Taxes on a Contract for Deed?
In a contract for deed arrangement, the buyer is usually the one responsible for paying property taxes. This means that the buyer will have to report the property to the IRS when they do their taxes and may recoup or benefit from any related tax exemptions or reductions.
In contrast, the seller can no longer claim any deductions or exemptions on their taxes for the property. Instead, they will have to report and pay ordinary income taxes if they are still receiving payments from the buyer under the contract.
However, laws regarding taxes, property, and contracts vary by state and thus should be reviewed for further guidance. Also, the parties may decide to negotiate terms in the contract that require the seller to pay taxes, so the terms of the contract for deed needs to be reviewed as well.
What Happens if Either Party Breaches the Contract?
A contract for deed operates in the same manner as any other contract. Basically, the parties must follow their respective obligations and duties as provided by the contract terms. For example, the buyer is required to make timely payments to the seller, and the seller must transfer the property title once the buyer pays in full.
If either party breaches the terms of the contract, then the non-breaching party can sue the breaching party for damages or for whatever remedy is required by their contract. There are a variety of ways that a termination of a contract for deed can happen.
For instance, if the buyer defaults, then the buyer can take back their property by simply cancelling the contract. They do not need to go through the process of foreclosure. Alternatively, if the seller refuses to provide title to the buyer after they have satisfied the full costs, then the buyer can sue for breach of contract and demand title.
What Happens If the Seller Dies During a Contract for Deed?
There are two main issues that can arise if a seller dies before the terms of a contract for deed are fulfilled. The first is who the buyer will make payments to if the seller is deceased, and the second is who will give the buyer title once all payments are satisfied.
Although the buyer may be able to prove that they had a contract with the seller, they do not own the property yet, so there could be a risk that the buyer loses possession of the property during probate. Also, even if they make full payment on the property, there is no guarantee that the seller has appointed anyone to give them title.
Thus, in order to prevent such a situation from happening, the buyer and seller should consider including these possibilities and their outcomes in the terms of their contract. This way both the buyer and the seller’s estate will be protected from future disputes in the event of this scenario.
Does a Contract for Deed Need to Be Recorded?
Once a contract for deed has been signed, the buyer has approximately four months to record the contract with the county recorder where the property is located. After paying off the contract in full and receiving title from the seller, the buyer will also be required to file the title deed with the county recorder as well.
Although the law does not require persons to record real estate documents, not recording them comes with many consequences. For example, if a buyer does not record their property, it will be extremely difficult for them to show true ownership, sell the property, and refinance their mortgage if necessary.
Thus, it is always better to record real estate documents because it can protect both the buyer and seller from future legal disputes and from having to prove they are the rightful owner of their property.
Finally, it is important to note that each state has its own recording acts. These acts provide general guidelines for how and when to record property. Therefore, they should be reviewed before recording a contract for deed or title.
Should I Hire a Lawyer for My Contract for Deed?
As is evident from the above discussion, contract for deed agreements can present many challenges and legal issues. Thus, if you need to draft a contract for deed agreement or are involved in a dispute over one, then you should contact a local real estate lawyer for further legal assistance.
Your lawyer will be able to explain more about what a contract for deed entails and the laws that apply to one in your state. Additionally, your attorney can help you draft and negotiate the best terms for your contract. An attorney can also represent you in court or through mediation if a dispute arises.