What is a Contract for Deed?
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How Does a Contract for Deed Work?
A contract for deed, also called a CFD, land contract, or bond for deed is a way to finance a property purchase. The buyer and the seller negotiate the selling price and terms. When the contract is signed, the buyer takes possession of the property, but the seller holds the title until it is fully paid.
With a contract for deed, the seller is acting as the lender, which means the terms of the loan can be negotiated with much greater flexibility than a conventional mortgage loan. The down payment, interest rate, amortization, and term of the loan are all negotiable; five years is a common loan term, but some CFDs have terms of 10 years or more.
Payments are also negotiable. Depending on the price and interest rate, buyers may pay off the loan after five or seven years of payments. Otherwise, the seller may agree to a balloon payment after the term should the buyer qualify for a mortgage. That keeps payments lower during the term of the contract, but puts buyers on the hook for a big payment to pay it off.
There are strong seller protections in a contract for deed. The seller can repossess the property if the buyer defaults, though the repossession process can differ depending on what is required by state law. In many cases, the process is faster and easier than a mortgage foreclosure, because the seller—not the buyer—holds the title to the property while the contract is in force.
On the other hand, buyer protections are not as robust. In certain states, if the property is repossessed, the seller must reimburse them for any material improvement and “reasonable” rent.
Advantages of a Contract for Deed
A contract for deed is a form of creative financing that puts property ownership in reach for people who cannot qualify for traditional financing. Everything is negotiable—the down payment, interest rate, monthly payment, and term of the contract.
The process is typically fast and streamlined; deals can be closed in days, not weeks or months. When buying commercial or investment property on a contract for deed, buyers can immediately fill it with tenants to start an income stream. The buyer can also enjoy allowable tax deductions, including interest on the loan.
For sellers, quick settlement and a wider range of buyers are the main advantages. This means that a seller who is willing to work with buyers who cannot get bank financing has a larger buyer pool. Also, most banks will not finance a property that is not ready to move into, but they can sell a fixer-upper as-is with a contract for deed.
Also, in many states, it is easier to terminate a contract for deed if the borrower defaults on their payments. Sellers do not have to go through a prolonged foreclosure process. In some states, sellers can repossess the property in about two months and get it back on the market quickly. On the other hand, foreclosures can take up to a year or more, depending on the state.
Risks of a Contract for Deed
There are different risks for both the buyer and the seller in a contract for deed sale.
In most states, defaulting on a CFD means the buyer has fewer legal protections and not much time to correct the deficiency. They stand to lose all the money they have paid to date plus the cost of any improvements they’ve made to the property. Depending on the contract, for example, a buyer can make all payments for ten years but only miss one and they could lose everything.
The seller holds the deed during the entire term of the contract. This means the seller could encumber the property with another mortgage or lien while the buyer makes payments.
The seller is not required to have a clear title when the contract is signed or while it is in force, only when the purchase price is paid in full. The seller could technically use the property to secure a loan to buy another house. If that lien is still in force even when the buyer pays off their contract, it usually takes priority over the CFD. One way to mitigate this risk is to record the contract for deed, so the ongoing transaction is of public record, which would generally keep other lenders from extending loans on the subject property.
Finally, while buyers can buy a contract for deed property without the disclosures required in a traditional mortgage, it also comes without the protections associated with it—appraisal, inspection, and title examination. The buyers may not know the true condition of the property. Although the buyer is responsible for property repairs whatever financing they choose, they would still have a better idea of potential problems when there are mandatory disclosures.
Meanwhile, the seller is still the legal titleholder, making it their responsibility to ensure sure the property is up to code and does not violate any local ordinance. This exposes the seller to potential lawsuits, fines, or other legal hassles if the buyer does not maintain the property adequately.
In addition, if the seller’s investment strategy requires cash up front, a CFD is not going to be a great deal of help. The title stays on a seller’s books for the term of the contract, which means they will not get their money for several years.
Special Considerations in a Contract for Deed
By signing a contract for deed, both the buyer and seller are committing to a financial relationship that will continue for the duration of the loan term. As such, any expectations regarding the property, the timing of payments, or otherwise should be spelled out clearly in the contract for deed, so there can be a clear remedy for any issues, should they arise.
- For the buyer: Verify with the county recorder that property taxes have been paid and the property is not in foreclosure.
- For the buyer again: Record the contract for deed or a contract for deed memorandum with the county recorder.
- Some states require a “Truth in Sale of Housing” report. An independent inspector may be useful to find this out.
- An appraisal protects both parties. If the purchase price is too high, the buyer may not be able to get a mortgage to fulfill the contract’s terms.
- The contract should specify how property taxes and insurance will be paid while the contract is in force.
- If there are any prohibited uses or limits to alternations on a property, these expectations should be laid out clearly in the contact for deed.
As with any legal document, it’s best to find an attorney who can draft the right type of agreement that fits your requirements. However, if a basic contract for deed template is saught, boilerplate and fillable examples can be found on websites like Rocket Lawyer and US Legal.
A contract for deed is a common type of agreement used with seller-financed real estate transactions, but there are risks for both the buyer and the seller. Due diligence is still required to ensure taxes are current, there are no clouds on title, and the appraised value is in line with the sales price.
- Rocket Lawyer. (n.d.) What Is a Contract for Deed? Definition and How it Works. Retrieved from https://www.rocketlawyer.com/article/what-is-a-contract-for-deed-ps.rl
- Schechter, R. (2019.) 7 FAQs About Contract for Deeds in Real Estate. Clever. Retrieved from https://listwithclever.com/real-estate-blog/7-faqs-about-contract-for-deeds-in-real-estate/
- Myslajek, C. (2009.) Risks and realities of the contract for deed. Federal Reserve Bank of Minneapolis. Retrieved from https://www.minneapolisfed.org/article/2009/risks-and-realities-of-the-contract-for-deed