Advantages and Risks
Contract for Deed Precautions
Most loans contain what is known as a Due on Sale Clause giving the lender an option to call the loan due if any interest in the property is transferred. This is also referred to as "accelerating" the loan. Contracts for Deed, Lease Options and Land Trusts all trigger the due-on-sale clause. There is no magic bullet to avoid it. This means there is a possibility the lender may discover the transaction and call the loan due. If this happens, the Buyer must refinance at current interest rates and terms. If the Buyer can not qualify for a new loan, he must sell or foreclosure may result.
Are Contracts for Deed illegal? No! Violating the due-on-sale clause is
not against the law, or criminal. It gives the lender the option (choice) to accelerate the loan.
While we can not guarantee the lender will not call the loan, our experience has shown lender’s do not seem to notice or care -- so long as the Buyer keeps the payments current. In fact, in over 30 years of handling Contract for Deed transactions, we have seen only one accelerated and that happened because the Buyer called the Lender and begged forgiveness. Interest rates had increased substantially and the Lender forced him to refinance at a compromise, but higher, rate than before.
Today, loans are handled by servicing companies who have no stake in calling the loan and losing their servicing income. These servicing companies handle hundreds of thousands of loans and don't go looking for trouble.
We find there are a large number of Buyers and Sellers willing, if not anxious, to make use Contracts for Deed.
Putting the Due on Sale Clause aside, here are some of the Advantages and Disadvantages of using a Contract for Deed:
Advantages for the Seller
1. No appraisal - your home's value is not determined by a third-party appraiser..
2. No financing contingency to worry about - you approve the Buyer's credit.
3. Wider range of potential buyers - those who might not afford a higher interest new loan.
4. Possible profit on financing – make up for a lower price by charging a higher interest rate than the existing loan with “wrap around” financing
5. Quicker settlement - no waiting six weeks for lender approval.
Risks to the Seller
1. The Seller remains liable on the loan until it is paid either through a refinance or sale of the property. If the loan is called it will reflect on the Seller. To protect the Seller, the Contract for Deed provides that upon default, the Buyer's interest terminates and all sums previously paid are rent. The Seller can evict the Buyer and take the property back.
2. The loan continues on the Seller’s credit report. This could present issues for the Seller to qualify on a new home. Most new lenders will count at least 75% of the Buyer’s payment as income to the Seller for qualifying purposes. If you are planning on buying a house soon, check with your new lender for details.
3. This risk of non-payment is similar to the risk assumed by any landlord. The contract for deed has an advantage over a lease because the Buyer is paying the full cost of the mortgage, homeowner fees and maintenance. In addition, the Buyer has paid closing costs and has an ownership interest. Unlike a lease, there are no maintenance, management and move-out hassles.
4. The Buyer never goes through a formal application process. Sellers should insist on accurate and complete credit information. Ask to see a copy of the credit report and tax returns. Pay a friendly mortgage lender to evaluate the application. Insist on a reasonable down payment under the circumstances.
Advantages for the Buyer
1. No loan qualifying - you only need to satisfy the Seller not some distant and inaccessible loan underwriter.
2. Low or flexible down payment - whatever you and the Seller agree.
3. Favorable interest rates and flexible terms - whatever you and the Seller agree.
4. Lower closing costs - no loan fees, junk fees, Total closing costs are about half of those charged on a new loan.
5. Quicker settlement - no waiting weeks for lender approval.
Risks to the Buyer
1. Three to five years is a minimum recommended term. This allows time for a refinance or sell. It gives time for the property to appreciate and the Buyer to earn more money or resolve credit issues to qualify.
2. If the Buyer defaults, the Contract for Deed terminates the Buyer's interest and treats all payments as rent. The defaulting Buyer could stand to lose his investment.
3. A lender who discovers the transaction may call the loan immediately due and payable. If the Buyer can’t qualify for financing, he will have to sell or foreclosure may result and the Buyer could lose the benefit of his investment.
If you want to use Contract for Deed financing, enlist the services of a qualified attorney to advise you. The attorney will also draft the appropriate disclosures and indemnities to protect all parties. The Buck Law Firm has handled hundreds of Contract for Deed transactions and can assist with yours.