Buying a Home Using Land Contract
For several people I have known, financing has been difficult even when they have good credit. These people have had to wait months before they were able to move into the home of their dreams. If you were a victim of the recent economic collapse and lost your home to foreclosure, even if you have pulled yourself up by your bootstraps, have paid off your debts, and have straightened out your financial position, your now not-so-friendly bank will probably turn you down for a loan. So what do you do? How can you convince someone to finance your desired housing without going through traditional financing channels? One of the ways to obtain financing is that you might be able to get the seller to finance your home. Here in the United States, this type of financing is a Contract for deed.
I am not an attorney and cannot advise you on whether a contract for a deed is your best option. To know whether this is your best option, consulting an attorney is highly advised.
Getting the Property Owner to Finance You
A contract for deed also known as (depending on the state) land contract, warranty deed, or agreement for deed, is a contract in which the owner retains legal title to the property until the buyer pays off the entire balance owed on the property. In a sense, it is similar to a layaway plan for the buyer except the buyer has the right to live on the property, improve it, rent it, and do anything the buyer wants as long as there are no clauses in the contract denying certain rights.
Advantages of a Contract for Deed
If you do not have any other source for financing, either because you do not have a credit history or your credit is poor, or other reasons, a contract for deed may be your only option. Closing costs for a contract for deed are often less than for conventional financing. The IRS in some cases will allow the buyer to deduct the interest payments as interest on a mortgage.
Why You May Not Want a Contract for Deed
Since you do not have legal title of the property under contract for deed, you cannot use your investment in the property as collateral for a home loan. Another issue is, If you do not make payments on the property which you are buying, it is easier for the property owner to foreclose, sometimes even without notice.
Be aware that some contract for deed contracts contains balloon payment clauses. Balloon payments clauses are clauses in which you agree to make payments to the property owner for a specific period of time, then you are expected to pay off the remainder of the debt all at once. Often this type of contract for deed allows you to have enough collateral in the property that you can then switch to a regular mortgage. Be sure that you will be able to make the balloon payment before you get into this type of contract for deed.
Getting the Seller to Sell to You on Land Contract
Before discussing the idea of buying the property on a contract for deed, discover the sales price. Once you know what the seller wants for the property, ask if the seller would be open to selling the property through a contract for deed. If the seller agrees to the contract for deed, discuss down payment. Be sure to discuss and determine agreeable terms and payment rates as well as when the contract requires a payoff. Get as many details off the table as possible. Determine the down payment, the payoff of the contract, the responsibility of property upkeep, payment of taxes and insurance, and possible resale of the property during the contract stage (before the contract is paid off and the deed is passed to the buyer).
However, once you have decided that you want to obtain your dream home using a contract for deed, the seller may decide however that he or she does not want to sell you the property on a land contract. One reason a seller may not agree to a contract for deed is that the seller wants the proceeds all at once, not trickling in a little at a time. Another reason the seller may not want to sell using a land contract is that even though the seller still owns the property, the seller will not legally be able to claim depreciation or other tax breaks for the property. If the seller currently has the property mortgaged, a contract for deed may violate a due-on-sale clause in the mortgage. Another reason the seller may hesitate to agree to a contract for deed is that in the event of non-payment and the property reverting to the seller, the property may have depreciated. Any of these issues can be worked around if you can convince the seller that selling the property to you on a land contract would be in his or her best interest. One of the major benefits of a contract for deep for the seller is that he or she can report the contract for deed as an installment sale on IRS Form 6252. In other words, the seller will be able to stretch the capital gains tax profit over a number of years rather than having to pay the taxes all at once. If the seller sells the property in a conventional manner, the IRS would tax the profit in the same year. Another advantage for the seller to sell to you on a contract for deed is that you are a willing buyer. In the current market, the seller may not see another potential buyer for a long time. Another reason is that the seller is selling the property over an extended period. The seller will collect a higher interest rate if the owner sold the property outright and banks the profits.
The seller may want you to pay off the contract and secure a traditional mortgage in a year or two. Before agreeing to this type of contract, be sure that you arrange for a bank or mortgage company to agree to take over your mortgage and pre-qualify you for a loan. Also, find out if the bank or mortgage company requires that the seller provide you with a quitclaim deed. This warrants nothing except that the seller is relinquishing a portion of or all claims to the property prior to you refinancing the property.
Signing the Contract for Deed
To protect you and the seller legally, both of you will need to get a lawyer. The expense of securing an attorney is worth it when you consider that you are hiring an expert who knows the language of a contract for deed. You need someone who will protect your investment as it accrues in property value. The seller under a traditional lender situation cannot begin foreclosure until the homeowner is 90 delinquent on payment. However, unless otherwise stated, a seller can evict a buyer after only one missed payment and offer no compensation for the buyer’s investment. Imagine having paid 40-50% of the property’s value and losing it because you forgot to send a check one month.
Your attorney needs to assure that the seller cannot encumber debt against the property that you are buying. Without this assurance, if a seller becomes late on payments, and the lender forecloses, the buyer could be evicted and may end up with a worthless contract. Your attorney will ensure your contract is recorded in your county clerk’s office so that any loan taken out against the property after the contract for the deed was signed will not affect your contract.
Request that your attorney completes a title search to determine that there are no liens against the property. Ask the attorney to explain how your state views contracts for deed and whether you will be able to file a homestead exemption with the tax office. A homestead exemption would allow you to reduce your property taxes if you live on the property full-time.
With attorneys representing both you and the seller, the attorneys will make sure that both you and the seller secure an equitable contract. They will verify a clear title, and that the exchange proceeds without difficulty. Your attorney will protect your interests while the seller’s attorney will protect the seller’s interests and you will both be able to sleep at night knowing that your interests were protected.
You will be required to have your down payment on the day you sign the contract. This down payment may be paid in whichever form you and the seller agreed, either in a lump sum or in time payments. Contract for deed down payments is not usually as high as a traditional mortgage is. Be sure to read over your contract and make sure that all details are spelled out. If it is not written down, it is not part of the contract. Ask your attorney about any wording in the contract that you do not understand. Be sure that you get a receipt of your down payment and copies of the cashier’s check or whatever your means of payment is for proof if you later seek a mortgage to pay off the contract. Remember, to make sure that your contract for deed is registered with the county clerk’s office. The title to the property will not be transferred until the property is paid off.
Be sure that you understand any restrictions that the property owner has on the property before you buy. For example, some contracts request that the buyer does not cut down any trees while the buyer is subject to the contract for deed. Be sure that you understand any easements that you have toward getting to your property as well as any easements through your property.
Once you have signed the papers, congratulate yourself! You are now can call yourself a property owner.
This article is accurate and true to the best of the author’s knowledge. Content is for informational or entertainment purposes only and does not substitute for personal counsel or professional advice in business, financial, legal, or technical matters.
© 2013 Cygnet Brown