The legal term “contract for deed” refers to a real estate transaction that takes place directly between the buyer and the seller, with no lender involved. It is also known as an installment purchase contract, installment land contract or bond for deed.
What is a contract for deed?
In a contract for deed transaction, the property in question is transferred from seller to buyer without the involvement of a third-party lender, such as a bank. Instead, the buyer makes their payments directly to the seller.
The two parties agree in advance upon the home’s purchase price, the down payment, the interest rate, the amount of each monthly payment and the length of time within which the purchase will be completed. Once agreed, the buyer takes possession of the property, but the seller retains the home’s title until the final payment has been made and the sale is fully executed.
When does it make sense to utilize a contract for deed?
This type of sale offers flexibility, giving both parties the option to tailor the terms of the transaction to fit the specifics of the situation. Here are some circumstances under which a contract for deed sale might make sense:
To avoid traditional financing
The ability to forgo lenders makes contract for deed appealing for buyers who are unable to secure a traditional mortgage, whether due to poor or insufficient credit, lack of down payment or other reasons. In a case like this, the seller might work out a higher interest rate than a lender would require.
In addition, during a period of particularly high interest rates, a seller may want to enter into a contract for deed, in the hopes that offering a discount on traditional rates will draw more potential buyers.
To save money on fees
Contract for deed sales can cost less than conventionally financed ones, because they sidestep many of the associated fees that come with a typical loan. Closing costs may be less as well, for the same reasons — particularly if the deal was worked out with no real estate agent involved.
To speed the home sale process
Conventional real estate transactions can take a long time. Between buyer, seller and lender, there are so many people whose schedules need to be worked out before everyone can sit down at the closing table together. Contracts for deed, however, can be speedy. All it really takes to file an official contract for deed is an agreed-upon deal between the buyer and the seller.
Of course, recording the contract for deed with your county’s registrar of titles or recording office is critical — not only does this recognize the intent of both parties in an official capacity, but you could face a fine if you neglect to do it.
When the seller and buyer know each other well
Contract for deed is often used when ownership of a property is being transferred within a family, from one relative to another. It can also be appealing for a sale that takes place between close friends who trust each other enough not to involve a bank or other financial institution.
Are there any negatives to a contract for deed?
As with all things, there are pros and cons to this type of untraditional transaction. If you’re thinking about entering into a contract for deed, here are a few important things to keep in mind:
- Because a contract for deed is outside the bounds of conventional real estate transactions, there are few rules or regulations governing them. When it comes to things like home appraisals and inspections, the usual stringent guidelines don’t necessarily apply. If you’re the buyer, make sure you fully understand the condition of the property before signing on the dotted line. Many contract for deed houses are sold as-is, so this is especially important.
- The buyer may take possession and move in, but until the sale has been fully executed and all payments have been made, the buyer does not actually have any legal claim to a contract for deed property. So you could conceivably run into more trouble than you think if you miss a payment or two. Unlike with a conventional mortgage, the selling party in a contract for deed arrangement is under no obligation to pursue legal channels for a foreclosure.
- Often, a contract for deed sale will include a balloon payment at some point along the payment schedule, usually toward the end. Buyers need to be aware of and properly prepared for this, so that the substantial increase in amount doesn’t threaten their ability to keep up with the payment schedule.
Bottom line
Ultimately, in a contract for deed arrangement, the sale isn’t actually complete until the payment terms are fully met. Until that time, the buyer does not legally own the house, and the seller has not legally sold it. Instead, what the buyer and seller have between them is the understanding that one party wants to buy and the other wants to sell, and they’ve agreed to the terms by which that will happen. The contract for deed is a legally binding roadmap for how they plan to fully execute that sale.
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