A contract for deed arrangement is one that allows a home buyer to purchase a property directly from the seller, without the involvement of a traditional mortgage lender or banking institution. It generally allows for a faster transaction and can open the door to buyers with less-than-perfect credit or a solid but short employment history.
By the end of this article, you will know that:
- A contract for deed is a written legal agreement between a property seller and buyer stating the buyer will only take ownership of the property once all conditions are met, including paying off a loan to the seller.
- Contracts for deed work very much like mortgages, in that typically there is a monthly payment to be made, and an amortization schedule showing how long the loan will last.
- Although contracts for deed can be very flexible, allowing them to be structured however the buyer and seller want, they also come with risk. Structuring a contract properly is very important.
What is a contract for deed?
The technical contract for deed definition is this: a written, legal agreement between a home seller and buyer that says the buyer will take ownership of the property once all terms and conditions have been met. As with a traditional mortgage lender, these terms include a total balance that must be paid off, along with interest along the way.
Though the buyer doesn’t technically own the property until they’ve paid the agreed-upon balance, they’re able to move onto the property while they re-pay the seller. Once the balance has been paid and all terms of the contract are met, the seller conveys the property deed to the buyer, and the home belongs to the buyer.
How does a contract for deed work?
A contract for deed arrangement functions very similarly to a traditional mortgage financing deal, with the seller acting as the lender in this situation.
The buyer makes payments to the seller on a monthly basis, along with added interest. As the buyer pays down their balance, the seller retains the title and deed, as well as legal ownership of the property.
In the event that the buyer fails to make payments as agreed upon, the seller can repossess the property like a lender would in a foreclosure, although it may be treated more like a rental eviction, depending on the state. One warning, though: Some states allow contract for deed buyers to seek reimbursement for any improvements they made to the home or rent costs they’re forced to pay as a result of these actions.
How to structure your contract for deed
If you’re considering a contract for deed to sell your property, you’ll want to be thorough in drawing up your contract. There are a number of details you must include in the agreement in order to protect your investment and your finances.
You’ll want to stipulate the following:
1. Price: The total amount the buyer will need to pay in order to take possession of the home, less interest.
2. Term: This is the length of the contract. This is typically referred to as the loan amortization period. Though you can create as long a term as you and the buyer would like, remember that longer terms mean a longer repayment period. It may be many, many years before you recoup your costs on the property.
3. Interest rate: You do not have to offer an interest rate that is comparable to current mortgage lenders. In fact, if you want to make a profit — as well as potentially sell your contract for deed down the line — you’ll want an interest rate of 8.5 to 11 percent, given current market conditions. You also want to make sure that you stay within the usury laws of the state the property is located within. This can easily be done with a quick google search.
4. Payment structure: You can opt to divide the total balance up into even monthly payments across the term of the loan, or your buyer might prefer smaller payments for the first portion of the loan, with a larger balloon payment at the end. Keep in mind that a note buyer generally will not purchase your contract if you opt for a balloon-style payment structure unless all of the factors are structured in an attractive way.
5. Property use: Though most contracts for deed allow the buyer to reside on the property as if they owned it, some sellers might prefer to retain access to the home. Other sellers might also offer maintenance and repairs like a landlord would. These details must be stipulated in the contract.
6. Insurance and taxes: The contract should also detail which party is responsible for insurance (homeowner’s, flood, etc.), taxes, HOA fees and other annual assessments during the term of the agreement.
7. General details of the property and parties: You’ll need to include the legal description of the home (found on the deed or at the local property tax office), as well as the full legal names and contact information for both buyer and seller.
Be sure to use an experienced real estate attorney if you’re considering a contract for deed arrangement. Every transaction of this type is different and can be completely customized to the parties and property involved. An attorney can help ensure you’re both adequately protected. It is WORTH the money!
Contract for deed benefits
There are many benefits to the contract for deed arrangement — both for buyers and for sellers. On the buying side, contract for deed solutions offer buyers with less-than-perfect credit and employment verification issues a solid route to homeownership.
They also allow transactions to move faster, given the lack of a traditional mortgage lender (and their lengthy underwriting processes). This can be beneficial to both buyers and sellers, cutting weeks off the process in most cases.
Contract for deed arrangements are also incredibly flexible. Both parties can customize the contract to their unique situation, coming to an amenable agreement that benefits everyone.
Finally, contract for deeds allow sellers to circumvent current market conditions. If there’s lots of housing supply and no demand, they can attract buyers who are shut out of other options. If mortgage rates are high and buyers are scared off, they can offer lower interest rates and generate solid, monthly income.
Contract for deed disadvantages
The biggest drawback of a contract for deed arrangement is the delayed revenues. You might get a small increment each month, but unless your term is very small or you’ve required a very large down payment, you might be waiting many years — or even decades — to recoup on your investment.
There are also risks with taking on a buyer who couldn’t qualify for traditional financing. They might end up defaulting on the loan, which would impact both your cash flow and your investment strategy. Buyers also may not take proper care of the property or keep it up to local code (or HOA regulations), both of which can cost you as you retain ownership of the home.
Because of these disadvantages, it’s always important to properly vet potential contract for deed buyers. Talk to their past landlords, pull a background and credit report, and don’t put yourself or your real estate investment at unnecessary risk.
Considering an Owner Finance Contract for Deed?
If you’re considering a contract for deed arrangement for selling your property, make sure you know how to structure your mortgage note for resale with a note buyer’s interest in mind. Should you tire of managing the payments or property, a note buyer can purchase the contract or mortgage note from you, allowing you to exit the arrangement easily with a cash offer. Learn more about selling real estate notes or contact a note buyer today.
Source for interest rate estimates: