A contract for deed, also known as a land contract, installment contract, or a bond for deed is a legal agreement between two parties, a buyer and a seller. Unlike most traditional real estate transaction that involves a mortgage from a bank, in a contract for deed transaction, the seller acts as the lender and provides the financing to the buyer.
With current mortgage rates, we have been getting more questions and handling more transactions for owner-financed sales. This can be a very useful tool that has clear advantages and disadvantages. Let’s dive a little deeper into the subject.
How a contract for deed deal should typically work: The buyer and seller agree. Among other things, they need to agree on a purchase price, down payment, interest rate, and payment schedule. Once the contract is signed, the buyer can take possession of the property immediately. The loan term is typically 30 years but the buyer usually only pays the seller for 3 to 5 years and at the end of that term must pay off the balance of the purchase price with a traditional mortgage (the balloon payment). Unlike a traditional transaction, the seller retains legal title to the property until the buyer completes all payments. Finally, once the buyer receives the final payment, the seller transfers the title to the buyer completing the sale and contract.
A contract for deed can be advantageous for buyers who may not qualify for traditional financing. Traditional lenders have strict rules for qualifying for a mortgage. Using a contract for deed means the buyer could have an easier time qualifying, it is all up to the seller. An advantage for the seller would be the potential for higher returns on the deal. They can earn interest over time and it would give them a steady income stream from the property sale instead of one lump sum.
Contracts for deeds also carry risks. Buyers have fewer legal protections compared to traditional mortgages. Disputes can arise over terms of the contract, the buyer defaulting on the payments, or if the seller defaults on property taxes, it can affect the buyer’s ownership. For reasons like these, it’s crucial to have a clear agreement drafted by legal professionals to avoid misunderstandings and ensure both parties’ rights are protected.
Helpful Tips
If you are in the process of entering a contract for a deed transaction (buyer or seller), here are some important items to think about before signing on the dotted line:
- The purchaser does not own the property until they pay off the full amount per the contract.
- The contract must specify which party will pay real estate taxes during the contract period (as well as who gets to claim the property for tax purposes).
- The parties must decide who is responsible for maintaining homeowner’s insurance. The last thing you would want is for your homeowner’s insurance to lapse. Without a bank paying the insurance out of an escrow account I would suggest that the person who is living in the residence be required to maintain insurance.
- The contract should specify where the payments will be sent.
- The contract should specify the payment terms of the loan. The parties could choose to make payments bi-weekly or monthly. As with a standard mortgage, you generally have 14 days until a late payment charge can be added on.
- What is the actual purchase price for the home?
- What is the interest rate on the loan? Will it be fixed or variable? For accounting purposes, fixed will be much easier to track for both parties involved.
- What personal property will be left in the home when the seller moves out? It is best practice, to list all personal property that will be transferred in the deal in the initial contract.
Every city and county has its special requirements when transferring and recording real estate deeds and it will be in your best interest if you have an attorney who regularly deals in real estate transactions draft your contract so that you comply with all local ordinances. The contract should be filled out completely, easy to read, and easy to understand. Remember the basic reason for a real estate contract is for a judge to be able to understand the terms and conditions if you ever have to enforce the terms in a courtroom.