When we’re trying to purchase a home, we don’t often hear the term Contract for Deed, do we? Most of us will seek traditional financing like FHA, VA, Conventional, Rehab, etc., but we don’t often hear: “I would like Contract for Deed financing.” In addition, how many lenders do you know that have such a finance option available for those who want it? Not many.
For professionals unfamiliar with the Contract for Deed program who have received that request, please know that Contract for Deed financing is available. You just have to know where to look for it. In this article, I want to help you understand Contract for Deed financing as well as the Pros and Cons that accompany it. Hopefully, after reading this article, you will have a clear understanding of the process and know if this is the route you want to explore further.
Below are 6 Key Things to Understand the Contract for Deed
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You are here seeking Contract for Deed option. The reality is because there are roadblocks where you can’t qualify through a traditional financing. This doesn’t mean that you’re a bad person or you’ve done something bad that you got denied with traditional lenders.
It might be because you’ve recently lost your home, your business, filed for bankruptcy due to unforeseen circumstances. Now you have worked, save up enough for some down payment but you can’t purchase a house for your family due to the guidelines set by lenders and the housing developments.
For example, if you just recently went through a short sale, you have to wait a minimum of two (2) years before you can look at FHA financing on your next home. If you recently went through a foreclosure or bankruptcy, you’re looking at 3 years for FHA program or 5 years for Conventional program in order to qualify for financing to purchase a home.
One option is you could rent until you meet the requirements right? What if you have a larger family? Rental does come with its own restrictions. Beside, how many places have 4-5 bedrooms for your family and if so what’s the rent rate would looks like? If you are a savvy homeowner like me, you wouldn’t even want to explore that option.
You’ve just lost a big chunk of what you’ve built up, now you’re looking to pay for someone else’s mortgage for the next number of years? Options are limited so here we are, looking at purchase on a Contract for Deed.
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2. Buying a Car Process
When explain purchase a home on a Contract for Deed, I often want you to think of buying a car process. The financing terms are relatively the same. When you go out to purchase a brand new car and looking to finance it, you will have a better rate than if you were to purchase a used car.
The terms are anywhere between 24-72 months depending on your income and debt to ratios. You will have the legal right to the car as long as for make the monthly installment but when you default on your payments, says 60-90 days, your cars will be repossessed. It goes back to the servicer who hold the legal title of your car.
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3. Buying a Home on a Contract
When it comes to buying a home on a Contract for Deed, of course there is a lot more to it than like buying a car but I want to point out the similarities the two have. Which are the interest rate, the month terms and the default time frames. Now let’s dig deeper into the Contract for Deed home purchase.
The traditional financing is where the lender will issued a lump sum payment to the Seller and their Lender (if any) and you as Buyer will get a deed to the property with immediate possession.
Where on a Contract for Deed the Seller agrees to be the lender and allow the Buyer to pay for the real estate through installments instead of a lump sum. The Seller will hold legal right until the Buyer excised the terms as agreed on the contract. At that time, the Seller still convey legal title over to the Buyer by a deed.
The basic terms on the Contract for Deed can vary from contract to contract. It’s depending on what the Seller is willing to accept. Generally, the Seller will look for anywhere from 10-20% down of the purchase price. The interest on a Contract for Deed could be anywhere between 1-2.5% higher than the current market rate (as of 2020).
Lastly, it’s likely that most Sellers will only considered a balloon loan. What that mean is the Buyer will have anywhere from 3-5-7 years of fixed principal and interest payments. The monthly mortgage payment will amortize over a 30 years period but after the 3-5-7 years terms is up, it will turn into a balloon payment. The Buyer then have to come up with the remaining (often large) balance to pay the Seller. Otherwise they will be in default and risk losing everything they’ve invested in the last few years.
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4. The Pros of Contract for Deed
As a Buyer who’s looking at Contract for Deed option, hopefully you know what you have to do to get yourself ready to take over the loan when the term is up. The PROS on a Contract for Deed is the Buyer’s credit score do not have to meet certain guideline, Buyer could have been through a recent short sale, foreclosure, or bankruptcy. As long as the negotiation is acceptable to the Seller then the Buyer could buy. The down payment money doesn’t really need verification either. As long as the Buyer have the down payment.
That should be good enough. Once the Buyer closed on the property (or officially owned the house), the Buyer is responsible for utilities, property insurance, and property tax. Any repairs and maintenance will be on the Buyer. It is practically their property. They can claim property tax paid, interest paid when they file for their yearly tax return. The Buyer can even list the home up for sale if they see the market went up or say they feel they can get a better home after a couple of year.
If the Buyer plan to stay for good, they should plan accordingly like getting their credit score clean up, making sure all the derogatory items remove from their credit report. That way by the time they’re looking for new financing, there won’t be an issue with qualifying. Buyer, make sure to give yourself plenty of time to find a new financing so that you won’t be looking at default when your Contract for Deed term is coming to an end.
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5. The Cons of Contract for Deed
When the Buyer does not prepare themselves in advance, they are now facing The Cons of the Contract for Deed. When the Buyer default, the Buyer will lose all the money paid toward the property. The Seller can immediately take action and foreclose on the property and most of the time the Buyer has no recourse against the Seller. Buyer could be looking at 60 days before they get evicted out of the property.
Other issue Buyer could face is if the Seller file for bankruptcy while the Buyer hasn’t had a chance to take over legal title yet. Other cases is if Seller is in serious health condition and passed away, the property is now going through probate. Now Buyer’s contract is in jeopardize. Buyer should seek legal advice immediately since Buyer might have to go through extensive litigation to fight for ownership right to the property.
Or when Buyer is ready to have the legal title only to find out the property had a bad title. Maybe they did not go through the proper closing at the time they processed the Contract for Deed with Seller.
Last but not least, Buyer should check whether if there is still a mortgage on the property or not. Most Contract for Deed cases, the Seller owns it free and cleared. But if there is a mortgage on the property, Buyer make sure to have a copy of the written approval from the Seller’s lender allowing such Contract for Deed taken place.
As the majority of lenders can immediately foreclose the current loan they have with Seller if they discover a Contract for Deed sale took place. When the Seller signed for that mortgage, the due-on-sale clause become effective immediately. That mean when the owner of the property is looking to sell the property, whether it’s a traditional sale or on a Contract for Deed sale, the entire mortgage balance becomes due.
If Seller doesn’t follow through then they have breached the contract with the lender. For that reason alone, Buyer, make sure you have the lender’s consent in place before signing that Contract for Deed purchase.
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6. Contract for Deed Lenders
Buyer don’t get discouraged. It doesn’t mean all Contract for Deed sale are through Seller. There are Contract for Deed Lenders out there who specifically focus on Buyer group like yourself. It’s harder for consumer to find these lenders and not many agents know of them either but they do exist.
The typical terms these lenders look for are similar to what the Seller would look for. A typical minimum of 10%-20% down. Interest rates are anywhere between 1% – 2.5% higher than the current market rate (as of 2020). Terms normally run on a 5 years balloon.
For real estate professionals and Buyers, you don’t need to go looking for Seller who is willing to sell on a contract if you’re working with the lender who accepts Contract for Deed loan. You can look at any property on the market, negotiate your offer just as you were to shop for one on a traditional buying method. For agent, check with the lender to see how they preferred the contract to be written up when present to the selling side.
For Buyer, you will go through the normal buying process but when it’s time to close, the process will get handle a little different than the traditional closing. The closing on the property will go through the Title Company just like any other. Buyer will pay for closing service but they will not pay for Contract for Deed Lender closing cost.
The Contract for Deed Lender will fund the lump sum to the Seller and Seller’s lender (if any). Then they turn around and create a Contract for Deed with the Buyer. The Buyer don’t need to pay Lender closing cost at this time but will pay for Lender closing cost when they seek new financing.
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Going Full Circle
My heart go out to those who seek for these types of alternative option because I know they just went through some hardship otherwise they won’t be looking to go down this route. No one wants to pay for higher interest rate and the high risk of losing your hard earn money so easily.
Then again, often time it’s better than rent and wait out. So when you decide to choose this route, make sure you get all your ducks in a row as quickly as possible so you can get yourself out of the Contract for Deed loan the earlier the better.
For the professionals, when you’re helping a client purchasing a Contract for Deed, try to go the extra miles and keep a tab on them. Check in once or twice a year just to see how they’re doing. Maybe sending out reminders so they don’t forget as we always do in our busy lives.
Hopefully, they will reach out to you when they are ready to obtain the legal title and you can refer them to a few good loan officers who can help. Otherwise if they wish to sell, you can assist them with the selling process and help them look for their new home. Whatever it is, knowing you’ve gone full circle with a client is the greatest feeling, wouldn’t you agree.
I hope you find this article helpful. If you do, please share it on your Facebook page so many other can benefit from it as well. Thanks in advance!
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