A contract for deed is one way that a buyer may finance a home. With this method, the seller provides financing to the buyer. Once the buyer pays off the purchase price, they are then provided with the deed. This method is often used when a buyer does not have the necessary credit to qualify for traditional financing. A contract for deed is also known as a land contract or contract for sale.
A contract for deed, also called a land contract or contract for sale, is a financing option for buyers who do not qualify for a mortgage loan to purchase property. In a contract for deed, the seller finances the purchase of the property, much like a mortgage company in a more traditional mortgage situation.
The seller provides the buyer with financing for the real property in question. The seller holds the legal title and the buyer receives an equitable title. When the buyer pays the total agreed-upon sale price, they receive the deed to the property from the seller.
Real estate is a form of real property. It is defined as the land plus anything permanently attached to it, such as buildings, including homes, trees, and fences.
A real estate loan, or mortgage, is used to finance real estate. The borrower (buyer) enters into a legal agreement with a third-party lender (mortgage company, bank, or credit union) that requires the borrower to repay the loan, with interest and other costs, over a specified period of time. A real estate loan differs from a contract for deed in which the seller is the lender.
Both agreements offer the possibility of home ownership, the potential for the buyer to earn equity in the property, and similar tax benefits and deductions. The primary difference between a contract for deed and a mortgage is that with a contract for deed, the buyer does not receive the property deed or title until they pay off the entire balance.
Depending on state law, the seller may have the ability to include contract terms that allow them to foreclose if the buyer defaults and does not make their installment payments (often referred to as monthly payments).
Renters do not own where they live; they avoid home repair costs and can choose to move when their rental agreement ends. Renters do not gain equity in their home, whereas homeowners do, but they do avoid the risk of an underwater mortgage in the event of a housing collapse, as occurred in 2008.
A contract for deed is a contract for land. In general, these are very risky financial agreements, especially when compared to a conventional mortgage. Homeowners and home buyers may benefit from using a contract for deed, but that depends on several factors. Contract for deed sales can be a good option for those who wish to buy a home but cannot obtain a mortgage because of their credit score or other issue. This guide will teach you everything you need to know about these purchase agreements -- what they are, what is included, their pros and cons, how they differ from traditional agreements, and how they work for farmers, etc. With this information, you will be able to better assess whether they can meet your needs.
Because buyers in contract for deed agreements often cannot obtain a mortgage, wraparound contracts for deeds are common. In a wraparound arrangement, the seller already has and keeps a mortgage on the property. The buyer makes payments to the seller, who then uses the money to pay the mortgage and pockets any difference.
Sellers may also earn additional income through overrides. In an override, the interest on the wraparound exceeds the vendor’s mortgage interest. The seller earns the difference in interest.
A contract for deed should include the following:
Purchase price
Down payment
Interest rate
Number of monthly installments
Responsibilities of the buyer and seller
Legal remedies for the seller if the buyer does not make payments
Advantages -- Buyer
A contract for deed is a good option for buyers who cannot qualify for a traditional mortgage, including those who have an insufficient credit history, have poor credit, cannot make a required down payment, or cannot prove their ability to make payments. In addition, the procedure involved with securing a contract for deed is less complicated than the process for obtaining a traditional mortgage, making it an attractive alternative for an inexperienced buyer. The entire transaction for establishing a contract for deed is generally faster than the traditional mortgage-approval process; without a conventional third-party lender, closing can occur sooner and the associated costs will likely be lower.
Advantages -- Seller
A contract for deed enlarges the pool of prospective buyers; those who are unable to secure traditional financing will be encouraged to negotiate an arrangement. In addition, the seller retains title to the property during the contract period, providing them with security. Should the buyer default, the seller can keep all the payments the buyer has made, as well as title to the property; the buyer will no longer have an equitable interest.
Disadvantages -- Buyer
A buyer who breaches a contract for deed (defaults) during the contract period is subject to termination of the contract for deed by the seller; the buyer may lose all payments previously made (equity) and all rights to the property, as well as face eviction. Further, if the seller defaults on their own mortgage on the property in question, the buyer may lose their interest in the property, even if they are not personally in default.
Disadvantages -- Seller
In order to initiate a foreclosure under a contract for deed -- to obtain clear legal title to the property, the seller must take legal action in court, a more expensive and longer process than the foreclosure procedure allowed under a traditional mortgage. Also, a contract for deed usually includes a low down payment and is characterized by installment payments (monthly payments) -- a poor plan for having adequate funds on hand to buy another property.
Since they are most common in scenarios where a buyer cannot obtain a traditional mortgage, contracts for deed can be risky. However, there are benefits for both parties. They include:
Seller
Earns regular income at a better interest amount than in other investments, like deposit certificates.
Eliminates monthly expenses of owning the property.
The income can help pay down other debt.
Fast closing time and may have lower closing costs.
Attractive way to sell a property that is non-conforming or has a code violation so it cannot be sold on the standard real estate market.
Can minimize the costs of trying to find the perfect buyer in the standard real estate market.
Can distinguish the property from others, which might help it sell more quickly.
Buyer
Do not have to qualify for financing, as with a traditional mortgage from a bank, lender, or credit union.
A seller may, however, request a credit report.
Flexible terms: you can negotiate a low down payment, the length of the contract, interest, payment frequency, etc.
Faster and less expensive closing process.
As mentioned above, contracts for deeds can be very risky financial arrangements for sellers. As a seller, you need to do what you can to protect yourself. Doing so requires the following:
Requiring a copy of the buyer's credit report.
Be sure to check for red flags including bankruptcy, evidence of late payments, foreclosure sales, or evictions.
Purchase a title insurance policy.
This entails a search of public records which will reveal any judgments, liens, etc. that have been issued against the buyer.
Require a large earnest money deposit.
The larger the deposit, the less likely the buyer is to walk away (and forfeit the money).
Verify that the buyer is employed and earning sufficient income.
Check their references, especially former landlords and ask about their payment history.
Opt for short-term financing.
There are many ways to do this, including requiring a balloon payment every x number of years, even if you amortize payments for a longer period of time (ex. 30 years).
Make the buyer purchase a homeowners insurance policy.
Set-up payments through a disbursement account.
With this in place, the buyer makes payments to the disbursement account. The disbursement company then deposits the money into your account. This protects your personal information.
You can also have the seller pay property taxes through the disbursement company which will ensure the taxes are paid on time.
Include a late payment penalty in the contract for deed.
Include an acceleration clause.
This clause gives you the option of requiring the buyer to refinance if the property’s condition becomes a financial risk.
Talk to a lawyer.
Have them review the contract and ensure all clauses may be legally binding.
Contracts for deeds can also be risky for buyers because these contracts often come with higher interest. Here are other things to consideration:
When does the buyer become the owner?
As long as the buyer makes regular payments, they hold “equitable title” to the property. This means they have interest in the property. The seller cannot sell the property to a third party.
When the buyer makes the final payment, they acquire the legal title to the property provided that all conditions of the contract are met. To transfer title, the deed must be filed with the appropriate government office (usually the county recorder) and name the new property owner.
What if the buyer cannot make payments?
If a buyer is unable to make their payments, the vendor can file a “land contract forfeiture” with a court. In this scenario, the buyer forfeits all the money paid towards the contract and loses their equitable title.
If you want to explore selling your property using a contract for deed, here’s how to get started.
Add “financing available” on all advertising materials.
Create an information sheet on seller financing to give to potential buyers who visit your property. This will help them decide if a contract for deed is the right option for them.
If you are a buyer, you can always ask a seller if they are willing to discuss seller financing.
Farmers commonly use both contracts for deed as well as mortgage loans to buy farmland. For a farmer just getting started, a contract for deed might be easier and cheaper than trying to qualify for a mortgage.
Furthermore, down payments and interest may also be lower on farmland than on a mortgage loan. Plus, in a contract, you do not have to pay mortgage origination fees, application costs, and other fees charged by mortgage brokers or other third-party lenders.
For sellers, selling farmland with a contract has potential tax advantages because the money from the land sale is spread out, as opposed to paid in a lump sum.
A contract can also be a way to help a new farmer, maybe a family friend or relative, acquire farmland. They’re also generally simpler than a traditional sale as they do not require a realtor, mortgage approval, or formal appraisal.
As with virtually all of the history of housing in America, the history of contracts for deed is riddled with racial inequality and discrimination. From the 1930s through the 1960s, Black home buyers were not eligible for federal mortgage insurance and were thus unable to qualify for a traditional home loan. This situation created a black market for unscrupulous real estate investors who would sell property to Black families with a contract for deed amortized over 20-40 years. These contracts came with exorbitant interest, and often contained language for “land contract failure” if a single payment was late. Rather than provide a pathway to home ownership, this practice further impoverished Black families.
More recently, investigations into the effects of contract for deed sales found such sellers largely prey upon low-income communities. Families are often sold properties that are poorly maintained, not up to code, and come with high interest rates. Sellers in these arrangements often abuse eviction clauses, leaving evicted families without all of the money they have put into the property.
Contracts for deed are becoming more common because, roughly a decade removed from the 2008 financial crisis, many people still cannot obtain traditional financing.
A contract for deed is often not an attractive option for a buyer or seller. However, in certain scenarios it may be the best option for those looking to buy or sell a home. We hope this guide helps you navigate the contract for deed market in an informed manner that will help you avoid the minefield these contracts often entail.
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