A contract for deed is a method that can be used to finance the purchase of a home without using a traditional lender such as a bank or mortgage financing company. These agreements are directly between the buyer and the seller, and payment terms can vary widely.
When entering into the contract for deed, both the buyer and the seller sign a contract agreeing upon payment terms. The seller finances the loan. During the loan repayment period, the buyer lives in the property, but the seller retains the title.
Benefits of using a contract for deed
Easier qualifications
Many factors are taken into consideration when qualifying for a traditional mortgage. The borrower usually needs to have a good credit score and credit history. This requirement alone is enough to disqualify many people from qualifying for a mortgage.
Another requirement is proof of income, such as pay stubs, tax records, and W-2s, as well as employment history. Buyers who receive cash payments for their work may have a difficult time proving their income.
Finally, the buyer and seller may be able to agree on a lower down payment than the amount required with a traditional loan.
Lower costs
Since the buyer isn’t required to qualify for a contract for deed, many of the costs associated with a typical mortgage transaction aren’t applicable. For example, the buyer doesn’t have to pay for an inspection, an appraisal, or bank fees. The seller doesn’t have to pay a commission to a real estate agent, either. The buyer can still have the home inspected and appraised, but it isn’t required.
Time to close
Executing a contract for deed is quicker than a traditional mortgage due to the lack of red tape. Qualifying for a traditional mortgage and going through all the steps to close on a home can take several months, while a contract for deed can be completed in a single day.
Negatives of using a contract for deed
While this type of arrangement can have many benefits, there can be downfalls for both the buyer and the seller.
Default on the deed
Traditional mortgages require several months to go through the foreclosure process. This gives the buyer ample time to try to pay back any missed payments and make the loan right with the bank to avoid foreclosure. However, with a contract for deed, the seller can repossess the property after only one or two missed payments. This can occur in as little as thirty to sixty days.
Even more alarming is the fact that, depending on the wording of the contract, the seller can keep the downpayment and all of the payments made on the property when the contract is voided due to missed payments. In a traditional mortgage arrangement, your loan payments would have been earning equity. This means you could still get at least some money back even if your home were foreclosed.
Property repairs and liens
Like a traditional mortgage, the buyer is responsible for all home repairs and maintenance. Coming up with the funds to pay for major repairs could be a hardship for buyers who have poor credit and struggled to qualify for a loan in the first place.
Additionally, since the title remains in the seller’s name until the deed is completed, the seller has the ability to put liens against the property. Unlike a traditional mortgage, the buyer does not have the option of refinancing to gain a better rate or take equity out of the home.
Payment terms
Many contracts for deed have a large final payment at the end of the term. Typically, this is to allow the buyer to build up their credit score to qualify for a traditional mortgage at the end of the term. However, there is a possibility that the buyer may still not qualify for a conventional mortgage by the end of the term. They would be at risk of losing their home and all the payments they’ve made over the years.
A contract for deed can be a helpful way to allow those who can’t qualify for a traditional mortgage to buy a home. The process can be quicker and less expensive than a traditional mortgage. There are more risks involved with this type of contract, though, so be sure you fully understand the agreement before entering into it. Since laws vary from state to state, it may be good to sit down with a local real estate attorney to go over this type of contract before signing it.