Buying a property through contract for deed may seem like a good idea. Buyers who would otherwise not qualify to purchase a house may look at this alternative method as a means of getting into a home, but contract for deed purchases carry risks not found in conventional home purchases and may leave the buyer in a precarious situation.
Features of the Contract for Deed
A contract for deed is also referred to as a land contract. The seller of a property extends a loan to the buyer under an installment plan similar to a mortgage. The buyer avoids origination fees, settlement costs and the scrutiny of a mortgage lender. Buyers who do not qualify for a traditional loan are attracted to the contract for deed for this reason. The title to the property under a contract for deed remains in the possession of the seller until the conditions of the contract are fulfilled. The deed is held in an escrow account while monthly payments are made to the seller either through the escrow account or directly. When the last payment has been made, the deed is delivered to the buyer.
Pitfalls of the Contract for Deed
Risks abound for buyers entering into a contract for deed scenario. When a buyer defaults on a traditional mortgage, protective measures are in place to allow the buyer to redeem the property. In the event of a default of a contract for deed, the seller may evict the buyer, thereby avoiding a lengthy foreclosure process. This process may only take 60 days in some states. Courts now look more favorably on buyers who have fulfilled the majority of the contract and may protect the buyer from eviction, according to the Federal Reserve Bank of Minneapolis. The final payment of a contract for deeds is usually a large lump sum referred to as a balloon payment. This requires many buyers to seek a traditional mortgage. In the event the buyer does not qualify for a loan, the seller may reserve the right to cancel the contract and keep all prior payments made. Since the seller remains in title to the property, the seller may continue to encumber the property during the life of the contract. The buyers' interest in the property may be considered a junior lien and not take priority over the other liens and encumbrances, leaving the property vulnerable to foreclosure.
Termination of the Contract
Laws affecting contract for deeds vary by state, but typical options to terminate the contract for deed are via notice of termination by the seller or acceptance of a deed in lieu of terminating the contract. A deed in lieu of termination is a situation wherein the buyer deeds his interest in the property back to the seller. The alternate choice a seller may take in the event of default is to terminate the contract. The seller must deliver a notice to the buyer of the seller's intent to terminate the contract. The notice names the conditions of the default, terms of reinstatement that set out what the buyer must pay to redeem his interest and notice of the consequences upon failure to comply.
An unrecorded contract for deed will go undetected in a property search. File a copy of your contract for deed or an affidavit of equitable interest in your local Register of Deeds or Registrar of Titles office to alert others of your interest in the property.
An avid gardener, crafter and artist, Elaine Bolen turned her love for art into a BFA degree from the University of Kansas. Bolen became self-employed in real estate and worked in a nursery. An interest in sewing and crafting led her to sell items in arts and craft shows.