A contract for deed (aka “installment land contract”, “land sale contract”, or “contract”) is an effective tool for buying real estate with seller financing.
A contract for deed is an alternative to traditional mortgage financing. Under a contract for deed, the buyer gets possession of the property and makes installment payments of the purchase price over an extended period of time to the seller, who conveys legal title to property once the purchase price is fully paid. Unlike a regular closing, the contract for deed closing does not immediately convey title to the buyer. The buyer has “equitable title” under the contract, with the right to receive “legal title” (ie, the Deed) upon paying off the balance of the contract.
While the contract for deed is a security device, it lacks many of the formalities and buyer protections included in mortgage laws. The majority of contracts for deed include a forfeiture clause, which allows a seller, upon buyer’s default, to end the contract, regain possession of the property, and keep all payments made by the buyer. Compared to mortgage foreclosure, the seller can recover the property more quickly because he or she is not required to sell the property, observe notice and redemption rights, or file a court case. However, for a court to enforce a forfeiture of a contract for deed, the right of forfeiture must be expressly provided for in the contract. In some states, there is a specific procedure for forfeiture under a contract for deed, while in others the law is less clear. In a few states, a contract for deed must be foreclosed like any other mortgage.
If the seller has an underlying loan, then he can still sell the property by contract for deed, raising the price and interest rate to create a monthly payment spread. When there’s an underlying loan, the transaction is referred to as a “wraparound” or “wrap”. However, the underlying mortgage may contain a “due on sale” provision, which allows the underlying lender to accelerate the loan and demand payoff immediately of the property has been sold via contract for deed. In our experience, this rarely happens, because there’s no incentive for the lender to force a borrower to pay off a 4% loan when the market interest rates are 4%. Lenders would be more likely do enforce the “due on sale” provision when interest rates in the market are substantially (4-5 points) higher than the underlying loan. If this is the case, some parties will not record the contract in the county land records to avoid the lender discovering the “sale”. However, failure to record the contract can lead to other problems, such as a lien or judgment against the seller that would affect the title to the property.
As you can see, a contract for deed contains possibilities and pitfalls and should not be approached without qualified legal counsel.
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