What is it?
A contract for a deed, also called land contract or agreement for deed, is a type of seller financing. Seller financing is where the seller lends money to the buyer to help them purchase his/her property. In this type of sale, the buyer and the seller enter an agreement where the seller agrees to finance the buyer and the buyer usually puts in a down payment. This agreement also contains the payment schedule which the buyer has to adhere to. The title of the property remains with the seller until the buyer pays off the entire amount he owes. The buyer still can treat the property as their own through the contract period.
The buyer usually makes a down payment upfront and pays the rest of the money through an amortized loan or they pay some money through an amortized loan followed by a balloon payment that marks the end of the contract. They are responsible for repairs and maintenance, payment of property taxes etc. but the title still remains with the seller. Since this is considered a sale, the buyer is allowed to deduct the amount paid to the seller from their total income, as home mortgage interest deduction for tax purposes.
Advantages for sellers
- Sellers go for this method because they retain the title to the property and thus some rights over it.
- In the event that the buyer defaults on their payments, the seller can keep the money paid to them thus far and can also choose the re-sell or hold the property. This is generally done as a foreclosure and usually done within a short time frame, depending on the region you are. This is a very easy process and does not involve spending too much money or time.
- The seller can find buyers quickly using this method, since the financing is done by the seller themselves.
Advantages for buyers
- The factor that makes this attractive to buyers is that the seller provides the required finances. This is particularly useful for buyers who are unable to secure a loan through a third-party agency or a bank.
- The cost involved in the deal is very less compared to the traditional mortgage. There are no fees involved in this process.
Disadvantages for buyers
- This type of sale is usually not fully amortized, like a traditional mortgage. It usually involves a part of the total being paid as a balloon payment at the end of the contract. If the buyer is unable to make this payment, they risk foreclosure thereby losing all the money they have spent on the property. However, this is depending on the kind of agreement that the buyer and the seller agree to.
- Since the buyer is responsible for maintenance of the property, they risk garnering huge expenses. This can be avoided only if the buyer has legal assistance that insists on complete inspection of the property before signing the contract for deed. The buyer, who chose the contract for deed type of sale because of credit issues, might not be able to afford an attorney. Thus, in case of unforeseen expenses there are high chances of a buyer defaulting on their payments.
- The seller is only obliged to transfer title to the property at the end of the contractual period. There are no rules that prevent the seller form making other deals on the property until the loan period is over. This puts the buyer at a risk of losing all their investment on the property unless precautions are taken. This is the reason why it is recommended that the contract is notarized and recorded legally so that the no one will be able to override the contract.
- The buyer might be in trouble in case the seller dies or goes missing during the contract period. They might have to go through expensive and time consuming legal process to claim ownership of the property.
Steps to be taken mitigate risk
- The first and the important step is to record the contract for deed in the local county. This discourages the seller from making other deals on the property.
- The buyer must hire an attorney and have them go over the contract before it is formally signed. This saves them from a lot of hardships they might face later.
- The buyer and seller must come to a mutual conclusion on the payment schedule and type, in such a way that it does not affect both parties. This will be included in the contract.
- The contract must discuss what will happen if the seller passes away or goes missing.
- The buyer, with the help of the attorney must conduct a thorough financial check on the property. This is to check if there are any pending mortgages on the property.
At the end of the day, both the buyer and seller do not want to be losing money in their deal. It is always best to be will informed of all the potential pitfalls in any deal. There are a lot of educational resources, like Renatus that offer courses on various topics on real estate investment. Happy investing!