by Harry Styron, Styron & Shilling, Ozark, Missouri
Contracts for deed, sometimes called land contracts, are documents that provide a form of seller-financing of real estate. This form of financing has been popular for decades as an alternative to a seller-financed transaction in which the seller conveys the property to the buyer by signing, delivering and recording a warranty deed at the time the buyer takes possession of the property, with the buyer signing a promissory note and deed of trust in favor of the seller.
The information contained here is based on Missouri law. Many other states have statutes and customs that are different than Missouri’s, so the information here may not be applicable to contracts for deed in states other than Missouri.
Seller’s preference for contract for deed may mask title defects and regulatory issues
Contracts for deed are most commonly used for the sale of lower-end homes, in situations where the seller does not have good title or there is something about the property that makes it worth much less than the contract price, such as:
- the seller inherited (maybe or maybe not, who knows?) the property, but didn’t do a probate
- the property does not have lawful access to a public road
- the house is illegally connected to a shared septic tank
- the seller does not want to make repairs that would make the house qualify for FHA or other mortgage underwriting guidelines
- the seller can’t or doesn’t want to pay off an existing loan and the buyer can’t get financing for a new loan.
Contracts for deed are also a common method for financing the sale of rural acreages and lots. The marketing these lots and acreages is done by classified ads, online and in print. Developments having fewer than 100 lots or having all tracts larger than 20 acres are exempt from the registration requirements of HUD’s Office of Interstate Land Sales Administration, so it’s strictly a buyer-beware game for large lots. Even for lots smaller than 20 acres, many sellers do not register their offerings with HUD.
Most of the counties in Missouri have no planning and zoning regulations outside of towns. When buying lots or land with seller-financing, whether by contract for deed or not, make sure that you visit the property in person and find out about the road access to the property, distances to jobs, schools, grocery store, and health care, before you buy. The ease of the seller-financing is intended to make the buyer less concerned about the actual purchase price and the financed cost of the property.
Contracts for deed in commercial transactions
For commercial transactions, I see contracts for deeds used most often for the sale of older motels and resorts. Often there is an existing loan payable to a bank or private lender (which may have a high penalty for payoff before maturity). The seller, sometimes with the lender’s permission, enters into a contract for deed transaction because the seller is no longer able to operate the property and the lender would rather tolerate the contract for deed than foreclose.
Mechanics of contract for deed transactions
The purchase of real estate using a contract for deed (rather than a deed to the buyer, with the financing in the form of a promissory note and deed of trust) is a common form of seller-financing that carries with it several risks to both sellers and buyers. A contract for deed looks like a purchase contract, but has a closing date usually several years in the future, after buyer has paid the entire purchase price to seller in installments.
When the transaction is accomplished with a contract for deed, the buyer is not entitled to receive a deed until the purchase price is fully paid, which often never happens. The buyer’s ownership is not shown in the county deed or tax records. Sometimes, a document (often titled “affidavit of interest”) is recorded to indicate that buyer’s possession of the property is under a contract for deed, but statutes and case law do not clearly define the rights of persons who are shown as buyers under contracts for deed.
In a conventional transaction, the seller signs, delivers and records a deed showing the buyer to be the owner. The buyer, at the same time, signs a promissory note and deed of trust (or mortgage) in favor of the seller. The deed of trust is recorded with the deed. The deed of trust creates a mortgage lien and allows the seller to foreclose if the buyer fails to make scheduled payments or defaults in another way described in the deed of trust or note, such as for failing to keep the property insured.
Someone told me that a contract for deed is a terrible way to buy real estate, but a good way to sell it. Maybe, but I’ve seen sellers in trouble in contract for deed transactions with nobody to blame but themselves. Lawyers call them “contracts for lawsuits,” which is often the case. Of course, lawyers never hear about the cases in which everything worked as planned.
Under Missouri’s power of sale foreclosure law, foreclosure of a deed of trust is usually a six-week or eight-week process (a little longer if the borrower is bankrupt) and does not require a lawsuit. Foreclosing a contract for deed often requires a lawsuit and takes six months or more.
If there is an existing mortgage loan against the property when the buyer takes possession under a contract for deed, that loan usually becomes due on demand, because the terms of most loan documents for houses have “due-on-sale” clauses, which are triggered by sale by contract for deed. If the seller doesn’t make payments on the seller’s mortgage loan, the buyer can become homeless without much if any notice. In addition, the applications of insurance proceeds after major storm or fire damage may result in disputes or great inequity to buyer or seller, depending on the circumstances.
Risks to Buyers
- Seller cannot or will not deliver deed when property is paid off, due to death, disability, dispute over payment history, or title problem. Sometimes the seller is just contrary or dishonest. Sometimes an honest seller needs money and sells the contract for deed to a dishonest seller for cash.
- Seller is a couple. They divorce, with the former spouses disagreeing on all financial matters, with one refusing to sign anything until he or she receives an unrealistic amount of money from the other. Buyer can’t get a deed until the warring spouses settle their differences.
- Seller may default on seller’s existing loan, triggering foreclosure (often without notice to buyer), causing buyer to lose equity and a place to live. Seller is usually in default at outset if there is an existing loan, having violated the due-on-sale clause.
- Buyer does not receive notice of delinquent property taxes, and property is sold by the county collector, resulting in buyer losing equity and a place to live.
- Because of seller’s liabilities, property becomes encumbered by additional liens, such as for seller’s unpaid child support, income taxes, sales and employment taxes, and judgments against seller, robbing buyer’s equity and possibly depriving buyer of a place to live.
- Buyer may get nothing (and may not receive notice) if house is taken by eminent domain.
- The lot or tract that Buyer has paid for is not a lawful lot recognized by the local planning and zoning authority–because it was not shown on a recorded plat or because of its size, lack of proper access, or improper water or sewer connections–so a deed to Buyer, even if signed by Seller cannot be recorded and cannot pass good title.
- Buyer takes possession and makes investment in property usually without obtaining title insurance.
- Buyer may lose substantial equity if buyer defaults.
- Buyer has no right to sell property, even after it is mostly paid for.
- Seller may sell property, and new owner does not recognize buyer’s rights under contract for deed.
- Seller does not disclose title flaws to buyer, and buyer makes large investment in property blindly.
Risks to Sellers
- Getting a defaulted buyer out of a property may be more difficult and expensive than under a deed of trust, because personal service of summons is required, rather than service of foreclosure notice by certified mail. The quick remedy of unlawful detainer is not always available.
- A buyer does not maintain the property as well as the buyer would if the buyer’s name was on the deed, since buyer doesn’t feel fully invested in property. Nor does the buyer get notice of nearby rezoning applications, condemnation proceedings, or delinquent property taxes, and will blame the seller for any complications caused by lack of notice or inconvenience.
- The due-on-sale clause in any existing mortgage loans on the property may cause the lender to demand immediate payment in full at an inconvenient time.
- Most contracts for deeds do not provide the protections for the seller found in leases or deeds of trust pertaining to damage and destruction, condemnation and addition of taxes and insurance costs to loan, and buyers will pocket insurance proceeds rather than repair the damaged property.
- If the seller’s own note and deed of trust are not paid off when the sale under the contract for deed occurs, the due-on-sale clause will be triggered, unless the lender has consented to the new sale. Failing to notify the lender, if the lender is a federally-related institution (a bank or if there mortgage insurance backing the loan issued by Fannie Mae or Freddie Mac), the sale could be construed as mortgage fraud or money laundering under various federal criminal statutes.
Under the best circumstances, the buyer’s payments are collected by an escrow agent who is holding a quitclaim deed signed by the buyer in favor of seller to record if buyer misses an installment payment and a warranty deed signed by seller in favor of buyer to record when the last installment is made.
However, there are technical problems with these deeds, which can become problematic. In the case of the bankruptcy or disability (onset of Alzheimer’s or stroke) of the buyer or seller, these deeds could be totally void.
If the buyer can’t afford to buy, but the seller wants to give the buyer a chance, a better solution might be a lease with a purchase option. The purchase option does not require the buyer to complete the purchase, which some sellers object to. The way to commit the buyer is to agree to give a substantial credit against the purchase price for rent paid.
Motivated sellers and buyers will often find ways to do what they want, regardless of legal advice. But they really shouldn’t use contracts for deed.