The Contract for Deed: A Buyer’s Last Resort

After the housing crisis began in 2007, it became much harder for potential home buyers to qualify for a mortgage loan. 

Buyers’ options for financing a home were limited.  But wealthy homeowners and investors looking to sell their real property could afford to offer a mortgage alternative called a contract for deed (sometimes referred to as an installment land contract or long-term land contract). 

In a contract for deed, the seller (in legal terms, the “vendor”) finances the sale of the real property to the buyer (the “vendee”), rather than the buyer obtaining a loan from a lending institution (like a bank).  The vendee takes possession of the property and agrees to make monthly installment payments of principal and interest until the principal balance is paid off.  In the meantime, the vendor retains legal title to the property until the final payment is made, at which time the vendor must execute a deed to the land in favor of the vendee.

Contracts for deed are risky for both the vendor and vendee.  Much of the risk surrounds the vendee’s lack of something called an equitable right of redemption.  In a traditional mortgage (buyer acquires financing from a lending institution rather than from the seller), when the buyer defaults, the buyer still has a right to pay any past due amounts up to the date of foreclosure.  By getting current on the loan, the borrower negates the foreclosure proceedings.  The redemption period varies among each state.  In a contract for deed scenario, however, the vendor may cancel the contract and retake possession of the property much earlier than under a traditional mortgage, giving the vendee much less time to catch up on payments.

Additional risk surrounds the vendee’s equity built in the home.  Traditionally, if the vendee missed a single payment, the vendor could take possession of the property and keep all the vendees prior payments, even if the vendee had already paid a substantial portion of the purchase price.  Vendors are even more likely to quickly cancel the contract and evict the vendee if the value of the property has increased since the time the contract was made.  Today, courts are more sympathetic to vendees and may afford them some type of remedy, such as extending their time to catch up on payments before allowing the vendor to retain possession of the property.  Available remedies for vendees vary from state to state.

The vendee faces even more risk due to the simplicity and resulting ambiguity that accompany most contracts for deed.  These contracts often do not contain important protections for the vendee—they fail to require a title search, title insurance, an appraisal, and a home inspection (each of which are required for a traditional mortgage).  This often results in the vendee having to pay for home repairs related to undisclosed defects on the property, which could cause the vendee to fall short on a monthly payment.  The contract also typically fails to spell out cancellation proceedings, making it harder for vendees to protect against vendors seeking to take advantage of a faithful vendee’s brief default. 

There are other, more subtle risks for vendees as well.  While not a completely one-sided deal (vendors also face substantial risks in these types of contracts, though not as many as do vendees), a contract for deed should be a last resort for buyers who are unable to qualify for a traditional mortgage.  If a buyer must employ this method for purchasing real property, it is imperative that the buyer enlist the help of a competent attorney to thoroughly spell out buyer protections in the contract for deed. 

If you’re considering using a contract for deed in an upcoming real estate transaction, whether you’re a buyer or seller, you should contact an attorney to help you draft, review, or negotiate the contract to ensure you are adequately protected.  For assistance, contact a Sioux City, Sioux Falls, or Omaha attorney today.