What does a contract for deed mean?
What are the advantages and disadvantages?
How does a contract for deed work?
In this article, we will break down the concept of “contract for deed” so you know all there is to know about it.
We will look at what is a contract for deed, look at its advantages and disadvantages, how they work, why you should sign one, the typical terms in a contract to deed agreement and more.
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What is a contract for deed
A contract for deed (or some call it an agreement for deed, bond for deed, land contract, land contract for deed or installment land contract) is a type of agreement where you purchase a real estate property directly from the seller without having to get a mortgage to finance the purchase.
Instead of financing the purchase of a property through a bank, financial institution or lender, the buyer finances the purchase directly with the seller.
A contract for deed is a type of seller financing model
This can be a good option leading to homeownership if you are unable to get or don’t want a conventional mortgage.
In a contract for deed transactions, you’ll typically agree to pay the seller for a set period of time until you fully pay the purchase price.
The seller keeps the title to the property but, in exchange, will contractually agree to transfer you the title when you have fully paid the purchase price.
In a contract for deed, the seller keeps the title to the property
This way of purchasing a home, land or any other type of real estate property can be cheaper and simpler than buying a property using a conventional mortgage (or deed of trust).
Contract for deed definition
According to Cornell Law School’s Legal Information Institute referring to Nolo’s Plain-English Law Dictionary, a contract for deed is defined as:
A contract used for seller financing where the seller will keep title to the property until the buyer pays off the loan. After the buyer pays off the entire loan, the seller signs a deed transferring title to the buyer.
What is notable with this definition is that the seller financing the transaction keeps the title of the property until the full purchase price is paid by the buyer.
How does a contract for deed work
A contract for deed works in a similar way as a traditional mortgage with certain key differences.
Agreement on terms
To purchase a property, the buyer will first need to agree with the seller on two main aspects:
- The purchase price
- The financing terms and conditions
Closing of transaction
Once the buyer and seller agree on the purchase and financing terms, the next step is to go to closing.
The key difference is that at the closing of the transaction, the buyer does not acquire the title to the property (the seller keeps the title).
Term of financing
After the closing, the buyer will need to make his or her payments directly to the seller (not a bank or financial institution).
Typically, the term of a contract for deed is about five years.
Full payment of debt
At the end of the term, the buyer will generally be asked to clear all outstanding debt with the seller so he or she can get title to the property.
This means that the buyer will need to make payments throughout the term and at the end of the term, he or she will either need to make a balloon payment (payment of a large sum of money) to clear the debt or get a traditional mortgage from a bank to acquire title to the property.
Title to property
The buyer can claim title to the property once all the purchase price is paid (or the last payment is made to the seller).
Why sign a contract for deed
In certain situations, contract for deed homes can be an interesting option for both buyers and sellers.
The terms and conditions of a contract for deed are largely left to the discretion of the buyer and the seller.
You do not have a bank or a lender in the middle imposing legal obligations and imposing restrictive covenants.
Keeping the lender out of the equation can provide some flexibility to the parties
Buyers and sellers can find it advantageous to negotiate directly with one another and to keep the bank out of the equation.
Having the ability to negotiate your cash down payment terms, monthly payment obligations, interest rate, contract term and other aspects of the financing transaction can provide additional flexibility that you may not find going through a conventional lender.
What are the benefits of a contract for deed
Contracts for deed do offer benefits to both buyers and sellers.
What are they?
Benefits for the buyer
For some buyers, going the “contract for deed” route may actually be the only way they can purchase a real estate property.
If you do not qualify for a conventional mortgage, an alternative will be to have the seller “finance” your purchase through a deed of agreement
You may be able to buy a property even though you had filed for bankruptcy in the past
You may buy the property of your dreams even though you may currently not have a job or be employed
In these situations, a contract for deed may be a solution for you.
All you need to do is find a seller who is willing to do the sale directly with you.
In a nutshell, a buyer will have the ability to buy a property:
Let’s face it, a contract for deed is not for everyone.
However, if these advantages are dominating factors for you, then this may be the right path for you to homeownership.
Benefits for the seller
Sellers in a contract to deed transactions can also find their bargain.
You want to sell your property but due to the condition of your property, the buyer’s lender does not want to finance the transaction
You must sell fast and you want to sell to the first bidder
You are looking to make some profit by directly financing the buyer’s purchase
In these situations, sellers will find it advantageous to sell their property by entering into a real estate contract for deed.
To summarize, here are some of the possible benefits of contract for deed transactions to sellers:
This type of setup is not suitable for all sellers.
However, if a seller wants to take advantage of any of the above points, then a contract for deed may be the right thing to do.
What are the disadvantages of a contract for deed
Unfortunately, in life, not all good things are only good.
Contract for deed deals are risky and have important disadvantages.
Let’s look at the disadvantages of a contract for deed for both the buyer and the seller.
Disadvantages for the buyer
Buyers are exposed to contract for deed disadvantages.
Buyers do not own the property
The biggest risk is that you do not really “own” the property until you have fully paid off the purchase price.
In a contract for deed agreement, the seller retains the title of the property until you have fully paid the purchase price.
When the seller is fully paid, then he or she will transfer the title of the property to you.
Termination of contract for deed
Another risk is that in the event of a default (any default provided in the contract), you can lose the property right away.
Unless you have negotiated specific terms governing the default procedure, a seller can immediately take over the property and terminate the contract.
On the other hand, with a conventional mortgage, the bank must legally grant you 30 to 60 days to cure any default before repossessing.
Sellers can grant liens to on property
Another consideration is that even though you have technically bought the property, the seller “legally” owns the title and can grant liens and encumbrances on the property.
This means that the seller can grant a third party lender rights on the property exposing your property to repossession, foreclosure or liability that must be discharged before the seller can transfer a clean title to you.
No appraisal before purchase
Since the contract for deed transactions does not involve a bank, lender or third-party financing company, in many cases, you may choose not to appraise the property before the purchase.
This can represent an important risk as you may purchase a property that appears to be in good shape but may have significant defects.
If the defects do creep up, you’ll be responsible to pay for the costs to repair them.
Strict default provisions
In many cases, sellers will impose strict default provisions on you.
As a result, a seller will have the ability to evict you and take over your property quickly without having to go through the same judicial process as a bank would in the same circumstances.
In many cases, sellers have a much stronger bargaining power
Sellers, particularly the professional ones in the business of contract for deed, have much stronger bargaining power and have the ability to impose their terms and conditions.
The buyers are usually unable to qualify for any other form of financing and will accept the strict terms offered by the seller.
High rates of interest
A financial disadvantage is a fact you will need to accept to pay a much higher rate of interest to the seller for the financing.
This is expected as contract for deed transactions are high-risk in nature.
Sellers will have no incentive to take on a high level of risk without getting a commensurate compensation.
Unexpected home repairs
When you sign a “contract for deed” contract, you will be legally responsible for maintaining the property and paying for all the property costs.
You run the risk of purchasing a property with important defects resulting in unexpected and surprise home repairs.
According to the contract terms, these are costs that are yours to assume.
If not, the seller can consider you to be in default and take over the property.
Disadvantages for the seller
Sellers are also exposed to the contract of deed disadvantages.
Property remains in seller’s name
One major drawback is that the property will remain in your name until you have received the full purchase price.
This can mean for many years.
You will legally remain responsible for the property for years to come.
This can expose you to lawsuits and potential liability for the actions of the buyer.
Seller does not get full purchase price
In a conventional sale of a property, you expect to get the full purchase price immediately on the day of the closing of the real estate transaction.
This way, you realize your profits and can move on with your life.
However, in a contract for deed, you will not have the ability to realize all the profits at closing.
Typically, the buyer will make a small cash down payment upfront and then pay the rest of the purchase price over a period of several years.
As a seller, you will need to wait several years before you can realize all your cash flow.
Mortgage on the property remains in sellers’ name
If you sell your property on a contract for deed basis and you have a mortgage outstanding, you’ll remain responsible and “stuck” with your mortgage.
This means that you remain liable toward the bank and you must continue to respect the terms of your mortgage agreement and make your monthly payments.
If you do not receive your monthly installments and are unable to make your own mortgage payments, you run the risk that your creditor repossesses your property.
This can be harmful to you and the buyer.
Buyers may not be reliable
Another important drawback for you is that, quite often, the buyers in a contract for deed purchases do not have great credit.
Although some buyers may be reliable, most may not.
This means that you may have to run after your money and go through the inconveniences of dealing with a delinquent payer.
Typical contract for deed terms
A contract for deed will have typical terms similar to any other financing transaction.
You will typically find the following terms:
- The term of the contract
- Term extension provisions as required
- The interest rate applicable to the financing
- Sale is usually on an “as-is” basis
- Payment structure (monthly, biweekly, weekly, lump sum, balloon payments or other)
- Obligation of the seller to transfer title to the buyer
- Sellers will usually maintain the right to grant liens and encumber the property
- Obligation of the buyer to properly maintain property
- Obligation of the buyer to assume all costs and expenses on the property such as property taxes, property insurance, homeowner association fees and other
- Termination of contract and eviction procedures
- Contract registration or “contract recording” with the registrar of titles
Typical, the average term of a “contract for deed” contract is for five years.
Also, a ‘contract for deed’ is a flexible arrangement between a buyer and a seller.
The parties can mutually agree on any suitable provision or modify any of the terms of an existing agreement.
Rent-to-own vs contract for deed
A rent-to-own contract is similar but not the same as a contract for deed.
A rent-to-own contract is an agreement where a person agrees to rent a property for a certain period of time and have the ‘option’ to purchase the property within a specified period of time.
The renter does not have an obligation to purchase the property.
In a rent-to-own, you lease the property and have an option (not an obligation) to buy
If the renter exercises the option to purchase the property, then the rent paid up to that point will be considered as a payment towards the purchase price.
Just like any other lease agreement, the renter:
- Is not responsible for the property taxes
- Property maintenance
- Property insurance and costs
- Does not have the right to make modifications to the property
- Does not have the right to act as if he or she is the property owner
On the other hand, the main purpose of a contract for deed is to sell the property to the buyer with the only difference that it is the seller who is financing the transaction.
As part of the financing terms, the seller keeps the title to the property (as protection) until the full purchase price is paid.
In a contract for deed, the buyer is responsible for the property maintenance costs, property taxes, and all other associated costs.
Contract for deed FAQ
Is contract for deed a good idea
Purchasing a contract for deed property is a high-risk option for acquiring a real estate property.
There are many scammers and predatory practices in this area and buyers should enter into this type of contract with great caution.
Buyers should be careful of scams and predatory practices in this area
Although there are legitimate opportunities for purchasing a property on the basis of a deed of agreement, you can also fall into the trap of a seller imposing strict contract terms, collecting your money and then leading you to default.
These scammers will then rinse and repeat this process with another buyer.
The laws do not regulate such transactions as much as conventional mortgages are regulated.
A seller can potentially put the buyer in default, trigger an eviction process and repossess the property without having to go through a foreclosure procedure or take legal action the way conventional lenders are required to do so.
Is contract for deed the same as rent-to-own
A contract for deed is intended to have a person buy a property whereas the rent-to-own is a combination of a lease agreement along with an option to buy a property.
Just like you may lease a car and eventually exercise your option to buy, you can lease a real estate property and eventually exercise your option to buy the property.
That’s what we call rent-to-own agreements.
In a contract for deed, you are actually buying the property with the only difference that you are not getting the actual title to the property until you pay the seller the full purchase price.
As an “owner”, you will be responsible for all the property costs, expenses and taxes.
How to buy a house using contract for deed
When buying a contract for deed property, it’s important to ask the right questions and be diligent.
Here are some tips to help you along the way:
- Do an appraisal of the property
- Ask questions about the zoning
- Ask questions about any past defects or damages to the property
- Ask whether there have been claims made against the owner
- Are there liens registered on the property
- Are the taxes fully paid
- How will the interest be calculated (is it compound interest or fixed interest)
- What are the payment options
- Can the buyer make early payments to clear the debt
- What are the charges for late payment fees
- In what situation can the seller consider you in default
- What is the exact termination or eviction process
- What will happen to the money you already paid in case of termination
- Will you get a statement from the seller on what’s owed and the interest calculation
- How are the expenses paid
- What is the procedure to get the title of the property once all payment is done
- Can the seller register a lien against the property
- The contract registration process
What are the contract for deed pros and cons
Contract for deed pros:
- You can buy a property with a poor credit history
- You can buy a property with a past bankruptcy on your record
- You can buy a property without having a job
- You will not need a conventional mortgage
- You do not need to qualify for financing
- You may not need to pay high closing fees
- You will have the ability to negotiate flexible terms
- You can agree on suitable cash down payment
- You can agree on suitable monthly installments or payment structure
- You can negotiate the interest rate
- You can define a quick settlement of the debt
Contract for deed cons:
- You are not the property owner until you pay the full purchase price
- The seller can quickly put you in default and terminate the contract
- Often, sellers can grant liens on the property
- Often, the property you buy will not be of great quality
- The seller will try to impose severe default terms on you
- You may end up paying very high interest to the seller
- You may end up with unexpected home repairs
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