Contract for Deed- How does it work?

[huntingislife]

We are looking into buying some land and have noticed several sellers offering contract for deeds. How does this work? How would payments compare to a conventional loan?

[BobT]

A contract for deed means that you are borrowing the money from the seller and using the property as the collateral.

How you calculate interest is determined by how you agree to calculate interest.

I sold a house on a contract. The two of us sat down and wrote our own contract. We used forms drafted by an attorney that we purchased at a local office supply retailer.

First - a purchase agreement.

The purchase agreement spells out some details involved prior to closing on the actual contract. It basically identifies what we agreed to.

For example, it records details about earnest money.

1. Was earnest money put down?

2. Is the earnest money refundable?

3. If refundable, under what conditions?

4. Is the earnest money applied to down payment if the purchase goes through?

The property tax was an item on the purchase agreement.

1. Will one party pay the tax for the sell year or will it be pro-rated?

2. If pro-rated, how is it calculated?

Other things are included like

1. Details about the title. Who is responsible for cost of title search and making sure of clear title.

2. The abstract. When is it to be delivered to the buyer and who is responsible for the cost of bringing it up to date.

3. How long is the purchase agreement valid?

4. Can the seller sell the property to someone else while the agreement is valid?

3. Other things that elude my memory right now.

Basically it spelled out the details of the purchase that we agreed to.

Next, the contract

The contract spells out the details of the loan.

What is the interest rate?

How is it calculated?

What is the payment going to be?

When is the payment due?

What is the length of the contract

In our case, we set up ten year ballooning contract, which means the balance is due in full after ten years.

We use simple interest where each month we take the anual percentage rate divided by 12 times the unpaid balance for the month. APR / 12 * unpaid balance.

I am now considering offering them the opportunity to lower their interest rate a percentage point and prorating it back to the beginning of this year. They have been extremely prompt with their payments and I'd like to reward them in this way.

Our contract comes due next February and I'm also considering an offer to extend the contract rather than make them pay the balance in full.

Hope this is helpful.

Bob

[huntingislife]

Thanks Bob. In general, are interest rates lower or higher than a typical loan?

[BobT]

Typically, I believe the interest rate on a C/D is higher. Sellers are not banks and probably don't have the capital to support contracts. I believe there is a law in MN that limits how high the rate can go but I don't recall what it is.

Ultimately, as a seller, I would not enter into a contract without requiring money down. In my case, I asked for 10% but that might be a bit low. The market was poor for the house I was selling and I was interested in getting it off my books.

The down payment serves a few purposes.

1.

It can go a long way toward confirming the buyer's committment.

2.

If the buyer goes into default, he's got something significant to lose so it makes him more likely to pay.

3.

If the buyer goes into default, you'll have the cost and pain in the butt of foreclosure, cleanup, repairs, and resell. The downpayment should be high enough to offset this.

Final comment. I am not in real estate and I am not an attorney. My comments are purely from my own experience. I have purchased a house on a contract and sold a house on a contract and both interactions went very well.

Bob

edit: One other thought. If you're looking at buying/selling land, most banks hesitate to lend money for land because land by itself is typically not considered adequate collateral. Just food for thought.

[Charley]

Also its for someome who can't get a loan.

[BobT]

I guess if they can't get a loan from a lending institution, and I know this up front, be darned they would get one from me if I were selling. Too risky for a bank, certainly too risky for me.

Bob

[Charley]

C/D where popular during the early 80's.

[Tom7227]

Bob has things spelled out pretty well. I bought my first house on a CD. Things were going OK until I got the payment book back one time and found a page of entries had been erased and re-written. The seller had allowed a real estate company to act as the servicing agent. I then found out that they had not been putting the tax and insurance escrows into a bank account as was required by law. I bailed on that deal by borrowing the money from a relative and then getting a conentional loan.

My daughter had a CD on her house and there always was an issue at the end of the year on how much could be claimed as interest expense for income tax purposes.

You could avoid the second problem most likely by just going to a HSOforum and doing an amortization table and agreeing in the contract that it is the basis for allocating payments to principle and interest. On the escrow problem - I guess if I was buying I would want to be able to make a check out twice a year payable to the registered owner and the county and send it to the registered owner a few weeks before the payment was due. That way they would know that the payment had been made.

It seems to me that having a short term CD with a balloon makes sense. Things change and you never know when a death or a divorce or something is going to come into play. With a shorter term you lessen your exposure. Hopefully after 5 years or so you'd have enough equity to get a conventional loan.

Be sure to have a clause that sets what the buy out amount is. You'll never be able to figure it out as closely as a bank does when you ask for a pay off on a home mortgage, but you want to have something that sets out how it is going to be calculated. Banks do it by determining the daily interest amount. Good luck with that calculation.

I can't remember if BobT suggested it but be sure to register the contract for deed with the county. It will cost you some fees but it puts the world on notice and would prevent the fee owner from using it as collateral or selling it to someone else.

If you're talking enough money that you pucker up thinking about it you probably should fork over some bucks and have a real estate lawyer look at it. Spending $500 now may save you from further problems, like learning that the place is a hazardous waste site or something. Going cheap isn't necessarily best when it comes to this sort of stuff.

[minndonn]

on a contract for deed the title stays in the sellers name until the final payment. Therefore if the buyer fails to pay it is quicker and easier to take control of the property and cancel the CD. You should always have an attorney do an opinion so you know you are purchasing a clean property. IF the seller has a mortage on it you should have the payments sent to the mortgage holder and applied to his loan the the balance sent to him of each payment. The opinion would help with this.

[echotrail]

My Grandmother sold her WI farm to a neighbor around 1980 on a CD for $10,000 down and $30,000 per year for 3 years. He missed the first payment and she extended him for 2 months. Still no payment so she contacted her lawyer and he started writing letters and charging her $50 per letter. She wouldn't forclose on the buyer becasue he was a family friend. She finally got the 1st payment about 9 months late. Of couse the same thing happened on the 2nd payment and I begged her to forclose, but she wouldn't. She got the last payment about six months late. Some years later after she passed away, my brother and I were settling her estate when we learned her lawyer was representing both her and the buyer and it was the lawyer who fronted the buyer the money for the last two payments.

[JPSavage]

I hate to say this ,BUT, you need to take legal action against that slimey lawyer....He is in violation of his code of ethics and the law....You will surely win.

[delcecchi]

No forclosure on a contract for deed I believe. The seller keeps title to the property in some fashion until the purchase is paid for. So if you violate the contract by not making the payment as called for, then the seller can take it back without all the foreclosure mumbo jumbo.

We bought our cabin on contract for deed years back. Loans were hard to get in the 80's

[delcecchi]

given the current situation, how could anyone recommend a short term loan with a balloon? Far better a long term with no prepayment penalty or only a small one.

Being under the gun to refinance has cost many their homes.

[Down Deep]

Bob T. explained a CD about as well as it can be. I do want to recommend that you hire a good land attorney. You can't get the type of advice you need from Office Max. I've purchased several properties with the use of a CD and they have all worked out good for me, but they were not without problems.

Real estate deals are complicated and fraught with potential snags. Don't go near this deal or any property deal without doing your due diligence. $500 to $1000 in attorney fees can save headaches that cost a lot more. Run into a problem with a property deal and that initial attorney fee will look like the cost of a tootsie-pop.

About 15 years ago I was going to purchase some raw land from a guy near the Lake of the Woods. Being that banks don't want to finance land deals I requested and he offered a CD. I had an attorney draw up the papers and do a deed/title search of the abstract. Turned out that the property deed was in the name of his dead father. I called the guy and told him he would need to have the deed transferred into his name and then we could do the deal. He said that property was willed to him and his brother. Both were willing sellers, but there was sister of record who lived in Texas. You know where this is going. I told him that I'd like to buy the property and asked him to call me when he got a clear title. About a year later I was driving back from Lake of the Woods and I noticed the same property was for sale again. I called the guy and told him I was still interested and asked if the title was clear. After a bit of mumbling he told me the property was off the market. So buyer beware.