What Is A Contract For Deed?
Before getting into the concerns you should have when buying or selling a house on a contract for deed, we need a definition. A contract for deed sale is the sale of a property where the owner has agreed to finance the sale on an installment contract. The buyer usually must make monthly payments in accordance with the agreement, and the seller retains title to the property until the obligations of the installment sales agreement are fully met. At that time, legal title to the property is passed to the buyer.
Usually, the contracts are written for terms of 10 years or less. It is not uncommon for the contracts to call for monthly payments based upon a regular 30-year loan amortization schedule, with a balloon payment for the balance of the loan being due upon the end of the agreement term.
What Are The Advantages For Buyers Of A Contract For Deed?
Some of the advantages include:
– A buyer may not qualify for a traditional mortgage and the contract for deed may be their only path to homeownership;
– A contract for deed may not require proof of income, which could be beneficial for buyers who operate in cash businesses (or illegal businesses). It can be difficult, for example, for waiters and waitresses to prove their tip income;
– Many people go through a financial rough patch in their lives due to a medical condition, loss of a loved one, loss of a job, or other life events. While the conditions that caused that rough patch may be behind you, their presence on your financial record may prevent approval of traditional financing today. A contract for deed can serve as a bridge to regular financing. You may be able to purchase a home on a contract for deed, establish good credit over several years, and then replace the contract for deed down the road with a traditional mortgage;
– A contract for deed may be the only financing available for homes that are livable, but are in poor condition or are very unique. A lender might be reluctant, for example, to offer a traditional mortgage on a straw-bale construction home or a home that is viewed as an over improvement for the area;
– A contract for deed may also be quicker to execute than a traditional mortgage, easier to execute (much less paperwork), and cheaper to execute (no points/origination fees/closing costs).
What Are The Advantages For Sellers Of A Contract For Deed?
– Willingness to accept a contract for deed expands the pool of potential buyers to include those who might not otherwise qualify for traditional financing. This may increase the potential sales price for the property. It may also make it easier to sell a property that is unlikely to be approved for traditional financing due to its location, condition, or uniqueness.
What Are The Disadvantages And Risks Of A Contract For Deed For Buyers & Sellers
Disadvantages and Risks for Buyer:
While laws vary by state, if you fall behind on payments, the terms of the sale may provide for a cancellation of the contract and a quick eviction from the property, with no equity in the property. In most jurisdictions, it is much more difficult for a bank to repossess a property and you are entitled to your equity interest, if any, after the bank auctions off the home. It often takes 6 months or more for a bank to foreclose on a home and evict you. In a contract for deed, it may take as little as 60 days. Your odds of losing your home from a short term disruption in your finances may be much higher when you have purchased a home on a contract for deed.
Contract for deed sales often are done without a realtor involved. A homebuyer who is not working with a real estate agent or real estate attorney may fail to make sure that there is a clean trail of ownership, that there are no encumbrances, and that there are no easements. They may also fail to properly inspect the home for its physical condition, presence of insects, presence of radon, or susceptibility to flooding. They may fail to get an appraisal to validate that the purchase price they are paying is reasonable. They may fail to purchase title insurance to assure a clean conveyance of title. 184 Tasks That Real Estate Agents Do For You
Another risk to the buyer is that the seller retains title until the debt is discharged. While the property may be unencumbered when the contract for deed is signed, there is the risk that liens are placed against the property at a later date, potentially having long term negative consequences for the buyer. It is therefore essential that the contract for deed be promptly recorded by the county.
A contract for deed could make it more difficult for you to sell the property as it may be difficult for you to sell your interest in the property under the terms of the agreement. You may wish to work with an attorney to craft acceptable wording on how you sell your interest if you wish to move before you have completed the payoff of the seller.
Disadvantages and Risks for Seller:
The buyer typically is responsible for paying property taxes, purchasing insurance, and properly maintaining the property. If the buyer fails to do any of these things (or worse, deliberately trashes the property) there can be significant financial loss to the seller. Those who watch episodes of HGTV’s hit show Flip Or Flop have likely seen that it is not uncommon for the occupants of a home that is being repossessed to trash the home on their way out the door.
Often times, contract for deed buyers are less credit worthy. The risk of default on such a sale can be higher, and you do not get your money up front like you do as a seller in a traditional sale.
Minimizing The Risks Of A Contract For Deed Sale
Because of the risks and disadvantages presented by contract for deed sales, it is essential that both buyers and sellers seek legal representation to review the contract for clarity, completeness, and fairness. The buyer’s attorney should also make sure that clean title is possible and that any liens or encumbrances are identified.
The buyer should insist upon a property condition report wherein the seller must disclose any known defects in the property, and any known present or prior issues with water damage, flooding, insects, vermin, structural issues, etc. The buyer’s attorney can provide a quality disclosure statement (some can be found on the internet as well). The buyer should also retain experts to inspect the property and should assess the exposure to flood and other hazards or adjacent exposures prior to executing the purchase agreement.
The seller should conduct a due diligence background check on the buyer to verify that they are a worthy and reliable purchaser. The seller wants to be comfortable that the buyer will be able to make payments, will responsibly maintain the premises, and will not be using the premises in a manner that is unconventional and likely to damage or diminish the value of the property. The due diligence may include a credit check, a criminal background check, references, a validation of employment, interviewing prior neighbors etc. It is important that the seller work with their attorney to make sure that proper disclosures, permissions, and procedures are used in any such background checks.
Once the contract for deed is executed, it is important that it be registered promptly in order to minimize the chance of future liens or other encumbrances against the property as a result of debts incurred by the seller.
How Does Insurance Work On Contract For Deed Sales And What Are The Risks?
Properly insuring a contract for deed property can be a complex situation, particularly if the seller has financed the property and the seller’s lender still has a financial interest in the property.
The contract of sale should specify who is responsible for the placement of insurance, the minimum coverage requirements of that insurance, and who is responsible for the payment of premiums. Most typically, it is the buyer who is responsible and a homeowners policy (HO3, HO5 or equivalent) is required.. When it is the buyer’s responsibility, the seller should request to be added to the policy using a lender’s mortgagee clause and also to be added as an additional insured on the liability. The seller should request copies of these endorsements and/or certificates of insurance evidencing the same, and should also request paid receipts for homeowners insurance each year. The seller should also validate that the amount of insurance purchased on the home is sufficient and that the perils covered are appropriate given the home’s location (flood, earthquake, windstorm if appropriate). It is possible to set up an escrow account with an escrow firm and to make this a requirement of the sale.
If the seller is responsible for providing the insurance, the seller likely will not be able to obtain a traditional homeowners policy (HO3, HO5, etc.). Most insurers reserve traditional homeowners policies for owner occupied homes. The insurer likely will not consider the home, in this instance, to be owner occupied. The seller will likely need to secure a quality dwelling policy from their insurance agent and to add the purchaser to the policy as an additional named insured or additional insured. Depending upon what coverage the insurer is willing to extend to the buyer, it may be necessary for the home buyer to purchase a separate renters policy to cover their personal liability exposures, additional temporary living expense exposure, and personal property exposures.
If the seller has financed the property, and has a mortgage on the property, properly insuring the property can be a bit more complex. The seller’s lender will continue to demand that they be shown on the insurance policy using a lender’s mortgagee clause. They may demand that the seller continue to be the one who places the insurance. The seller will need to work this out with their lender. If the lender allows the new buyer to purchase the insurance, it will probably be necessary to add both the seller and the seller’s lender to the buyer’s homeowner’s policy using a lenders mortgagee clause.
As these situations can be complex, it is highly recommended that you work with both your attorney and a qualified, professional insurance agent to get advice on how to address your needs properly.
Note: This article is only a summary and should not be relied upon to guide you through a transaction with the complexity of a contract for deed. The laws vary tremendously from state to state, and the appropriate actions by you will vary from transaction to transaction. It is important that both sellers and buyers in a contract for deed property sale retain a quality attorney to properly represent their interests.
Some other Enhanced Insurance articles related to Home Insurance:
Enhanced Insurance is not written by attorneys. If you’re looking for legal advice, you need to contact a lawyer. Further, insurance practices and forms change constantly and are varied from state to state. For definitive answers in your area, contact a local agent.
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