Contract for Deed for Underwater Real Estate Investors

A contract for deed is another option for underwater real estate investors when trying to sell their homes. 

Q: I recently read your article “Not a lot of help forthcoming to underwater investors.” I want to add another option for that real estate investor to consider.

Having been in the real estate business for about 50 years, I have occasionally run into similar situations. The “other” option is a Contract For Deed. Although I am not sure of the availability of this in all states, it has worked very well the few times needed by my clients.

This type of deed can be used to sell a property for a higher price to a buyer who has money, but may need one or more years to repair credit, but wants to buy now and complete the purchase at a later date. This can be a benefit to the seller as the seller can receive a substantial down payment and then monthly payment thereafter. These payments are usually higher than what he is receiving from someone who is just a renter. And, the buyer benefits from the fact that he is paying the taxes and insurance and gets the write off as the owner of the property.

Of course, the seller still retains the “ownership” of the property until the final purchase is consummated at that later date, and the seller must continue to pay his initial lender. But the seller is in a better position and now has cash in his pocket.

The buyer can work to improve his or her credit, save money, and then apply for a loan and buy the property. I recently helped a buyer with a Contract For Deed on the purchase of a home for $550,000. He put down $60,000 and closed on the property with a seller. Everyone was happy.

A: Thanks for your letter. We appreciate the information. A large majority of investment real estate investors want to take advantage of today’s lower interest rates when it comes to their properties. They may not want to sell, but they certainly are looking to lower their mortgage expenses.

These real estate investors have few choices when it comes to refinancing their properties. Some of them have properties that have declined in value and their prospects of refinancing are close to none these days. Others want to refinance but today’s lenders have a limited appetite to put more money into the real estate market.

However, you’re right about one thing. If you own investment real estate, you may have the opportunity to sell to buyers today that otherwise could not purchase the property through a contract for deed transaction (also known in some parts as an installment sale for deed).

The contract for deed route is a bit more complicated and carries some additional risks for both the buyer and the seller. In essence, as you stated, the seller and buyer sign a contract to sell the property to the buyer over a fixed period of time. The buyer and seller may meet to initially close the transaction. The seller receives an initial lump sum payment with the buyer promising to pay the balance owed over an agreed to length of time. When the buyer makes the final payment, the buyer is entitled to receive the deed to the property.

When it comes to seller risks, the buyer might fail to honor the contract and pay the monthly stipend, at which time the seller has to evict the buyer and take the property over. The seller also has to make sure the buyer does not cause damage to the property in any way that could prejudice the seller, such as by allowing liens to attach to the property that are not paid off, by failing to pay real estate taxes, or by failing to pay for insurance coverage on the property. In some remote cases, the seller could risk the forfeiture of the property if illegal activities take place at the property.

The seller can minimize some of these risks through good legal documentation, vigilance over the property and the activities of the buyer and vetting the buyer thoroughly before entering into the contract with the buyer.

On the other hand, the buyer has risks when he buys the property from the seller under contract. One of these risks is that the seller fails to pay his monthly mortgage payment on the property and the property goes into foreclosure. Another risk is that the seller undertakes to pay the real estate taxes and he does not and the property is sold for unpaid real estate taxes. Finally, if the buyer makes all the payments required under the contract, the buyer might run the risk that the seller won’t finalize the sale and transfer title to the buyer.

Here again, the buyer can minimize some of his risks by hiring a real estate attorney to prepare the contract for deed documents covering some of these issues. The document drawn up can make sure that money the buyer pays ends up paying for the existing mortgage along with real estate taxes. That the document covers the issue of how and when the seller must convey title to the buyer once the buyer satisfies the final payment under the contract.

An installment contract for deed can certainly be a great option for a seller that is looking to sell now and for a buyer that might have the ability to obtain the financing needed to close the property today. Most sellers and buyers will prefer to coordinate a more conventional transaction, with the buyer obtaining his or her own financing. But if the buyer is unable to secure financing, a contract for deed is a good alternative.

One last item: Some sellers might consider selling the property and then acting as the bank by holding the mortgage note. The difference here is that the seller loses a bit more leverage and control over the property and buyer. The buyer takes title to the property now and the seller becomes the lender.

Just as with any other lender, this seller will receive a note from the buyer promising to repay the debt along with a mortgage on the property giving the seller a security for the debt. After talking to a real estate attorney, the parties can decide which option will be better suited for their needs and requirements.


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