“We want all consumers to be treated fairly, and we monitor the marketplace to stay apprised of emerging developments in consumer finance,” Mr. Gilford said in an emailed statement. “As part of that work, staff from our research, markets and regulations division have had conversations with members of our consumer advisory board about land contracts.” He declined to comment on whether the agency had assigned two enforcement lawyers.
A contract for deed is a long-term, high-interest installment financing deal.
Actual ownership, or title to a home, passes to the buyer from the seller only after the last payment is made. The contracts, which can run for as long as 40 years, have become widespread in the Midwest and the South, where there are a large number of homes that sell for less than $100,000.
In the wake of the financial crisis, contracts for deed and other seller-financing arrangements have had a resurgence. The foreclosure crisis created a bountiful supply of cheap, often dilapidated, homes for investors to buy and left millions of people with damaged credit histories. Thousands of the homes that are now being sold to borrowers under contracts for deeds were ones that had been foreclosed on by Fannie Mae, one of two mortgage finance firms bailed out by the federal government.
The Consumer Financial Protection Bureau may or may not look to bring any enforcement actions over contracts for deeds and it is only in the early stages of researching the financing model.
The regulator, now nearly five years old, has been seeking to flex its muscles of late. Last week, the Consumer Financial Protection Bureau announced a new rule that would prohibit many financial companies from requiring customers to resolve disputes through mandatory arbitration. The agency is also said to be preparing a new set of regulations for payday loans — high-interest, short-term loans aimed at the same people as those who often enter contracts for deeds.
Contracts for deeds and other seller financing transactions have been around for decades, often used by family members or friends to sell properties to one another. But the arrangements have had a history of being predatory and the terms have often benefited the seller at the expense of the buyer.
Legal aid lawyers in 13 states say that the contracts are being aimed at black and Hispanic homebuyers, according to a national survey undertaken by the National Consumer Law Center. The center has begun to survey housing lawyers in states where these contracts are most commonly used, in part to help determine the effect of new institutional players in the market.
Statistics on the number of homes sold through contracts for deeds are hard to come by because not every state requires contracts to be recorded with the county. It is also not uncommon for borrowers to walk away from homes without contesting a seller’s eviction proceeding in court.
Often issues with homes that are sold through contracts for deeds emerge only once local municipalities bring cases against the sellers. Even then, the sellers sometimes do not show up to court and the code violations on their homes pile up.
Heather K. Way, a professor of law at the University of Texas, said: “This segment of the homeownership market cries out for greater federal oversight. It’s a toxic mix out there of sellers looking to make a quick and easy buck on the shoulders of vulnerable, unsophisticated buyers.” She added, “Unlike bank-financed sales, with seller financing there is typically no outside third party involved in the sale.”
Homes sold through a contract for deed often are put on the market “as is,” meaning buyers must spend a significant portion of their disposable incomes on repairs and renovations. When they do not — or cannot — problems result.
Municipal officials across the United States have complained that out-of-state investors selling properties with a contract for deed often tend to do little maintenance on properties and fall behind on paying property taxes or water bills.
“They do not take care of the code violations with these properties, which is why they are trying to pass them off to other people,” said Jill Steele, city attorney for Battle Creek, Mich.
Ms. Steele said Battle Creek has had a number of code violation issues with Harbour Portfolio Advisors, a firm out of Dallas that is one of the larger national players in the contract for deed business.
Harbour Portfolio bought more than 6,700 single-family homes following the financial crisis of 2008, most of them from Fannie Mae through bulk sales. In recent months, Harbour has sold more than 600 homes with existing contracts for deeds in place to other investment firms and individual investors.
The Consumer Financial Protection Bureau is trying to determine how many other firms are selling homes nationally with a contract for deed already in place or are renting out homes with an option to buy, said the people with direct knowledge of the matter.
Still, there are some in the housing market who think that contracts for deeds and seller-financing plans can help people with no credit get back on the housing ladder.
Odell Barnes, a longtime buyer and seller of foreclosed homes who operates out of Gilbert, S.C., chafed at the idea of government regulation in the industry and emphasized that seller financing contracts were a way to make homeownership accessible to anyone.
“Our government thinks all poor people are stupid,” Mr. Barnes said.Continue reading the main story
Risks and realities of the contract for deed
While contracts for deed offer some advantages over a traditional mortgage, such as speed and simplicity, they can entail distinct risks for buyers and sellers. This article presents basic facts and features of the contract for deed and offers suggestions for minimizing those risks.
Crystal Myslajek | Community Affairs Intern
Published January 1, 2009 | January 2009 issue
Because of recent credit tightening, some homebuyers may be less likely to qualify for mortgages than they were just a few years ago. Some financial counselors predict that borrowers with limited options may turn to alternative means of purchasing a home. One such alternative is the contract for deed.
In a contract for deed, the purchase of property is financed by the seller rather than a third-party lender such as a commercial bank or credit union. The arrangement can benefit buyers and sellers by extending credit to homebuyers who would not otherwise qualify for a loan. Indeed, public and nonprofit housing advocacy organizations have used the contract for deed as a tool to help low- and moderate-income households attain homeownership.
Nonetheless, this alternative financing mechanism lacks many of the protections afforded borrowers who have traditional mortgages. In addition, these contracts may contain provisions that leave room for abuse and can pose risks and uncertainties for both the buyer and seller. The following article presents basic facts and features of the contract for deed and offers suggestions for minimizing the risks associated with this mortgage substitute.
Facts and features
A contract for deed, also known as a "bond for deed," "land contract," or "installment land contract," is a transaction in which the seller finances the sale of his or her own property. In a contract for deed sale, the buyer agrees to pay the purchase price of the property in monthly installments. The buyer immediately takes possession of the property, often paying little or nothing down, while the seller retains the legal title to the property until the contract is fulfilled. The buyer has the right of occupancy and, in states like Minnesota, the right to claim a homestead property tax exemption. The buyer finances the purchase with assistance from the seller, who retains a security in the property.
The contract for deed is a much faster and less costly transaction to execute than a traditional, purchase-money mortgage. In a typical contract for deed, there are no origination fees, formal applications, or high closing and settlement costs. Another important feature of a contract for deed is that seizure of the property in the event of a default is generally faster and less expensive than seizure in the case of a traditional mortgage. If the buyer defaults on payments in a typical contract for deed, the seller may cancel the contract, resume possession of the property, and keep previous installments paid by the buyer as liquidated damages. Under these circumstances, the seller can reclaim the property without a foreclosure sale or judicial action. However, laws governing the contract-cancellation process differ from jurisdiction to jurisdiction and the outcome may vary within any one state, depending on the contract terms and the facts of the specific case.
Because the buyer in a contract for deed does not have the same safeguards as those afforded a mortgagor in a purchase-money mortgage, the contract for deed may appear to be essentially a rent-to-own arrangement. However, in a typical contract for deed, the buyer becomes responsible for the obligations of a mortgagor in possession, such as maintaining the property and paying property taxes and casualty insurance. In addition, unless prohibited by the contract, either party may sell his or her interest in the contract.
Speed, simplicity appeal to buyers
Homebuyers may be attracted to a contract for deed purchase for several reasons. This method may be especially appealing to homebuyers who do not qualify for a mortgage, such as people who work cash jobs and are therefore unable to prove their ability to make payments. Since the contract for deed process is significantly shorter than the mortgage-approval process, it may attract buyers who face time constraints or have limited options, such as people who are losing their homes to foreclosure. First-time homebuyers who lack experience in the market or individuals who are wary of traditional financial organizations may also choose a contract for deed because of the relative simplicity of the buying process.
Contracts for deed are a more popular financing alternative among minority homebuyers, most notably Hispanics. According to figures from recent American Housing Surveys, while only 5 percent of all owner-occupied households in the U.S. had contracts for deed in 2005, 9.5 percent of Hispanic owner-occupied households and 7.1 percent of black owner-occupied households across the country used them.1/ (For more figures on the use of contracts for deed, see the table below.) Though contracts for deed are sometimes referred to as the "poor man's mortgage,"2/ American Housing Survey results indicate that only 3.9 percent of U.S. households below the poverty line used them in 2005.
However, it is difficult to know exactly how prevalent contracts for deed are, because the nature of these arrangements allows the buyer and seller a degree of anonymity. Despite laws in some states that require the buyers or sellers in all contracts for deed to record the sale in the office of the county recorder or registrar of titles within a specified time period, the sales often go unrecorded due to a lack of financial and legal sophistication on the part of both parties involved in the agreement.
Percentage of Owner-Occupied Households with Contracts for Deed in the U.S.
|Percentage with Contracts for Deed,|
|Below poverty line|
|Elderly (65 years or older)|
Source: American Housing Surveys 2001, 2003, 2005, U.S. Census Bureau.
Before the rise of subprime lending in the 1990s, many buyers who were unable to qualify for traditional financing resorted to contracts for deed. Indeed, for most of the last century, the contract for deed was frequently used as an alternative to a mortgage or deed trust. Today, routine use of contracts for deed persists in some parts of the country. For example, in west central Minnesota, anecdotal information suggests that contracts for deed are a commonly used alternative to mortgages.
Still, some financial counselors and property law scholars regard the contract for deed as a "legal dinosaur"3/ or an "anomaly,"4/ and even call for its demise. They assert that the contract for deed has no place in modern property financing, offers no real benefits over the mortgage, and leaves both parties vulnerable to risk and uncertainty.
One major objection to the contract for deed is that it is closely associated with a form of predatory lending that was prevalent from the late 1980s through the 1990s. During this period, some neighborhoods—including those in North Minneapolis—experienced a predatory lending scheme known as equity stripping. In an equity-stripping scheme, an investor finds a homeowner facing foreclosure and approaches him or her with an offer to buy the home. After purchasing the home, the investor pays off the debt, sells the home back to the original owner on a contract for deed, and gains the equity from the transaction. Fortunately, these equity-stripping scams have faded from the scene in recent years—largely because homeowners facing foreclosure today have little to no equity for unscrupulous investors to strip.
Another objection to contracts for deed, apart from their association with nefarious equity-stripping scams, is that they have a reputation for offering little legal protection to buyers. Despite gaining home repair and maintenance responsibilities, buyers have limited ownership rights and control over their properties while they make payments to sellers. Buyers gain no rights of redemption through the transaction.
Until several decades ago, U.S. courts routinely enforced the forfeiture clauses of contracts for deed in the event of the buyer's default. For example, if a homebuyer missed a single payment 15 years into a 20-year contract for deed, the seller could cancel the contract and retain the title and all the previous payments, while the buyer would suffer a substantial loss. However, such extreme cases are less common today. While a few courts enforce forfeiture provisions as written, most have become more sympathetic to complaints brought by the defaulting buyer, especially in circumstances where the buyer has already paid a significant portion of the purchase price. Courts today often view the contract for deed as analogous to the mortgage and, consequently, extend mortgagor's protections to the buyer in cases of default.
The risks for buyers
Despite favorable changes in the legal enforcement of forfeitures, contracts for deed pose distinct risks for buyers. One major risk stems from the short time period required to cancel the contract in the event of default. For example, in Minnesota, when a buyer falls behind on payments, the seller can file a Notice of Cancellation of Contract for Deed with the county and serve the buyer with the notice. The buyer has only 60 days from the date of the filing to address the items of default and pay the allowable attorney fees to "reinstate" the contract. This is a short time span in comparison to the six months or more afforded mortgagors who face foreclosure. As a result, a defaulting contract for deed buyer has a much narrower window of time to find a new home and is likely to have limited housing options.
Another major risk for the buyer is the balloon payment. Unlike most traditional mortgages, the majority of contracts for deed are not fully amortized. Instead, the contract is most frequently structured to require monthly payments for a few years, followed by a "balloon payment" that completes payment on the house. To make this balloon payment, the buyer will almost inevitably need to obtain a traditional mortgage. If a buyer is unable to qualify for a mortgage at the time the balloon payment is due, he or she is likely to face cancellation of the contract.
Some buyers enter into contracts for deed with the hope of repairing their credit. They expect to improve their credit profile during the first part of the contract period and then qualify for a loan at the time the balloon payment is due. However, according to Dan Williams of Lutheran Social Services in Duluth, Minn., a contract for deed often does not improve the credit of the buyer because individual sellers typically do not report to credit agencies. The buyer may attempt to use a letter from the seller stating that he or she makes the contract payments on time, but unfortunately, most lenders do not honor such a letter.
Williams warns that unexpected home repair costs may also pose a risk to buyers in a contract for deed. While this risk also applies to buyers who purchase homes through conventional mortgages, it may be greater in the case of homes purchased through contracts for deed, because a seller can execute a contract for deed with limited disclosure about the condition of the property. Minneapolis-based attorney Larry Wertheim explains that in a third-party financed sale, the lender's stringent requirements for title examination, title insurance, and appraisal provide the collateral advantage of disclosure for the buyer. Unless the buyer in a contract for deed has legal assistance or is aware of the need for appraisal and title examination, the transaction may not include these safeguards. In addition, since many homebuyers choose a contract for deed because their weak credit precludes them from obtaining a conventional mortgage, they are unlikely to qualify for loans to finance repairs. Ultimately, defects in the property could increase the chances of the buyer defaulting on payments and losing the home.
Another risk for contract for deed buyers stems from the fact that the seller retains the title to the property during the life of the contract. Since the seller retains the title, he or she may continue to encumber the property with mortgages and liens. The seller is only obligated to convey good title when the purchase price is fully paid and it is time to deliver the title. He or she does not need to have good title at the time the contract is executed nor during the life of the contract. Depending on state law and whether the contract is recorded in a timely manner, the buyer's interest may be junior in priority to these pre- and post-contract encumbrances placed on the property by the seller.
In addition to the problems described above, no two contracts for deed are alike and, according to Cheryl Peterson of Twin Cities Habitat for Humanity, the terms of the agreement are often unclear. The contract for deed is typically a one- to five-page document that includes the amount of the purchase, the interest rate, the monthly payment, and some verbiage regarding cancellation. The documents often do not include a standard arrangement for beginning the cancellation process. This lack of clarity in contracts for deed creates difficulties for financial counselors who give advice to buyers facing forfeiture. According to Peterson, "You can't say, 'If you've seen ten contracts for deed, you've seen them all.' It doesn't make you an expert, because the next ten will all be different."
A tool for promoting homeownership
While the contract for deed may entail a litany of problems in the private market, this alternative financing device has proven to be a promising tool for the public and nonprofit sectors. Some housing funders and developers are using contracts for deed as a means of promoting homeownership for low- to moderate-income households. In particular, Minnesota Housing's Minnesota Urban and Rural Homesteading Program (MURL) has utilized contracts for deed as an effective tool to assist hundreds of Minnesotans in achieving sustainable homeownership while stabilizing declining neighborhoods.5/
MURL allocates funds to local administrators to rehabilitate deteriorating single-family housing. The rehabilitated homes are then sold to at-risk homebuyers on an interest-free contract for deed. The program defines at-risk homebuyers as those who are "homeless, receiving public assistance or otherwise lacking the ability to meet mortgage underwriting standards for traditional financing."6/
The MURL contract for deed requires homebuyers to make a monthly payment equivalent to 25 percent or more of their gross monthly income. (This is generally a good deal, considering that recipients of Section 8 federal housing assistance pay 30 percent of gross monthly income.) The goal of MURL is to allow homebuyers to eventually refinance or pay off the contract for deed and acquire fee simple title. The affordable monthly payments under the contract for deed allow the homebuyer to repair any outstanding credit issues while reducing the principal balance. Once the balance is reduced to a reasonable level, the homebuyer can refinance into a traditional mortgage.
According to a 2008 Annual Report Summary from Minnesota Housing, the MURL portfolio includes 350 homes. Over the past year, the default rate was 7.7 percent and the refinance/contract payoff rate was 2.6 percent. In contrast to the 60-day cancellation period in the private market, MURL includes a generous forbearance policy, designed to help the at-risk homebuyer be successful over the long term. It allows flexibility in cases of unforeseen circumstances that limit the homebuyer's short-term ability to pay (e.g., unexpected health issue, short-term loss of employment).
The Family Housing Fund—a nonprofit Twin Cities-based organization—is launching a new program that will also utilize the contract for deed as a tool to create affordable housing opportunities. The new initiative, titled The Bridge to Success Contract for Deed Program, launched in fall 2008.
Through this program, the Family Housing Fund made a $500,000 loan to Dayton's Bluff Neighborhood Housing Services (DBNHS) and Greater Metropolitan Housing Corporation (GMHC). These two organizations have a lender commitment—similar to a line of credit—of up to $1 million from a private lender. DBNHS and GMHC will use the funding pools to sell properties on a contract for deed to homebuyers who may not be ready to qualify for a traditional mortgage. The funds from the Family Housing Fund will make up 20 percent of the purchase price, with a balance of 80 percent funded by lenders. This arrangement eliminates the need for private mortgage insurance. Key components of The Bridge to Success Contract for Deed Program are homeownership education and financial counseling to ensure that the buyer is mortgage-ready in three years.7/
Advice from the experts
While a contract for deed may have its appeal as an alternative financing device, given the risks involved, buyers and sellers should proceed with caution when entering such an arrangement in the private market. The following advice from the Minnesota Legal Services Coalition stresses that both parties should make an effort to be fully informed.
- First and foremost, the seller must set forth the terms of the contract in a purchase agreement. It is important that both parties fully understand the provisions of the contract, because once the purchase agreement has been signed, the options available to both the seller and buyer are limited.
- The buyer should know whether he or she is responsible for property tax payments and insurance and whether the contract for deed includes a balloon payment. If it does include one, the buyer should be certain that he or she would be eligible for a mortgage to cover the payment when it comes due.
- The buyer should also make sure that the seller is the true owner of the house by checking with the county recorder's office to see who is listed as the registered owner. If the seller still has a mortgage encumbering the property or is responsible for paying the taxes or insurance, the buyer should contact the seller's mortgage company prior to signing the contract to determine whether the seller is current on his or her payments. Some "scam" sellers will retain a buyer's payments and not apply them to the mortgage. If the seller defaults on the mortgage in this scenario and the home is foreclosed, the buyer will lose the house and all the paid installments.
- The buyer should ask the seller for a Truth in Sale of Housing report to determine the condition of the house. This report is required in Minneapolis and St. Paul and some other cities. In cities where it is not required, the seller should find his or her own inspector to assess the condition of the home.
Finally, according to Wertheim, once the contract for deed is executed, the buyer should record the contract immediately with the county recorder's office or the registrar of titles. While statutes requiring this registration are rarely enforced, recording the contract will help prove the buyer's possession of the property and protect him or her from post-contract encumbrances placed on the property by the seller.
Ensuring a positive outcome
It is important to note that despite their risks and sometimes negative associations, contracts for deed are not intrinsically bad. When used wisely, they can be a good fit for some consumers. Contracts for deed offer a swift, streamlined option for people who do not qualify for traditional mortgages or would prefer not to deal with mortgage lenders. When administered by public agencies or nonprofit housing organizations, contracts for deed can be a tool for building credit, promoting homeownership, and stabilizing neighborhoods.
To protect their interests in contracts for deed, sellers and buyers must do their homework, so to speak, by making sure they learn and understand what specific provisions and risks the contracts entail. Buyers in private contracts for deed should take additional steps. These include assessing the condition of the property, confirming that the seller has clear title, and recording the signed contract at the appropriate government office. By being informed and prepared, the buyer and seller in a contract for deed can help ensure a positive outcome for both parties.
Crystal Myslajek served as a Community Affairs intern at the Federal Reserve Bank of Minneapolis in 2008. She is pursuing a master's degree in public policy at the Hubert H. Humphrey Institute of Public Affairs at the University of Minnesota.