Contract For Deeds

FOR SALE BY BUYER?

A contract for deed is typically used in transactions between private parties, where the seller, rather than a lending institution, is financing the purchase of the home for the buyer.  Typically, the contract requires the buyer make payments over time with interest payable on the unpaid balance.  After the deed is signed, the seller has legal possession of the property until the buyer repays the loan in full, usually through monthly installments.  This type of transaction can help encourage the sale of a home when the buyer cannot secure financing through a bank.  A contract for deed is recorded by the buyer with the country recorder where the property is located.  At Klun Law Firm, we can review the contract and explain any pending questions, making the transaction simpler.

Advantages and Disadvantages for the Buyer

A contract for deed is attractive to buyers who might not otherwise qualify for a loan due to lack of credit or a prior foreclosure.  Additionally, closing costs in a contract for deed is typically lower than a traditional mortgage since there are no applications or origination fees and the paperwork usually takes less time.  However, there are risks for a buyer in a contract for deed.  When a contract for deed is cancelled, the buyer loses the real estate, any money paid for improvements to the property and all money paid on the property to that point.  This can be especially difficult in contract for deed transactions involving farms and crops.  Also, the buyer does not become the owner of the property until payment is completed.  Until that date, the buyer only retains an equitable interest in the property.

Advantages and Disadvantages for the Seller

The advantage of a contract for deed to a seller is that the seller usually earns interest income on the property and retains legal title to the land.  However, a major disadvantage of doing a contract for deed is that the seller has to carry the financing themselves.  Additionally, the seller may need to offer credit terms to the buyer that a conventional lender may be unwilling to offer thereby increasing the potential sale price of a piece of property.  There is also a risk to the seller that the buyer may default and the seller may have to repossess the property.

Contrast with Mortgage

Like a mortgage, a contract for deed is a financing device which allows a buyer to purchase the property by borrowing funds from the seller who retains security in the property sold.  However, in a mortgage, a mortgagor-borrower obtains fee title at the outset and the mortgagee-lender has only a lien interest on the mortgagor's fee simple to secure repayment. In contrast, a contract vendor holds the fee simple legal title until paid in full.

Why must a contract for deed or other debt instrument contain an interest component?

The Internal Revenue Code recognizes the economic truth that a sum of money received today is worth more than the right to receive the same sum on some future date. A deferred payment transaction (such as a contract for deed sale) that does not contain an interest component fails to reflect the time value of money. Consequently, IRC Sections 1274 and 483 require that deferred payment transactions earn the seller a certain yield tied to rates periodically established by the Department of the Treasury.