Pitfalls of Seller Financing and Contracts for Deed

If you are a potential homebuyer but you are having trouble securing a loan, then seller financing could be a viable solution to your predicament. Seller financing works exactly as it sounds, instead of getting a mortgage from a bank, the homebuyer secures a loan from the seller. This can be a mutually beneficial option for both, buyers who cannot get approved for a loan, and for homeowners who are anxious to sell their house. In these transactions, the parties sign a Promissory Note that details the interest rate, the repayment conditions, and the consequences of a default.

While seller financing can often expedite the process of closing and cut down on bank fees, it also lends itself to the possibility of being abused by predatory lenders. The Consumer Financial Protection Bureau recently directed its attention to the rising prevalence of seller financed home transactions, particularly about a type of agreement called contract for deed or land contract. Seller financing is typically a short-term arrangement of five to ten years, with a balloon payment due at the end of the period or the anticipation of the buyer being able to qualify for a bank loan by then.

There are three major ways in which a contract for deed differs from a typical seller financing that makes them a risky option for homebuyers. First, the amortization schedule for these contracts can be as long as forty years, a decade longer than the typical thirty-year mortgage. In addition to that, they tend to have high interest rates, sometimes up to 10%. Finally, the buyer does not acquire title to the property via a Deed until the entire amount is paid off, which is rare. In a contract for deed, buyers have fewer protections than they would with a mortgage, and they can be evicted more quickly than in a foreclosure. Unfortunately, it is hard to estimate exactly how common forfeitures occur because not every state requires these contracts to be recorded.

Low-income people who are unable to qualify for a loan and are not as financially savvy often can fall victim to this strategy because they do not know all the risks. According to The New York Times, legal aid lawyers in thirteen states report that these contracts target minority buyers. Often, the homes sold in these transactions are fixer-uppers that have been bought in bulk by investment firms in the wake of foreclosure epidemic during the financial crisis. Since there is no outside third party involved in the sale, these homes are sold as is, putting the burden of repairing them on the shoulders of buyers. The houses sometimes require thousands of dollars in renovations of people who are already struggling financially.

While far from all contracts for deed and seller financing arrangements are predatory schemes, there are many other options that buyers and sellers might not be aware of. Some of these include lease-option, lease-purchase, equity sharing, wrap mortgages, and many others that might better cater to both parties’ needs.

Works Cited:

“‘Contract for Deed’ Lending Gets Federal Scrutiny.” Matthew Goldstein and Alexandra Stevenson. May 10, 2016. The New York Times

“Market for Fixer-Uppers Traps Low-Income Buyers.” Matthew Goldstein and Alexandra Stevenson. February 20, 2016. The New York Times

“The Ins and Outs of Seller-Financed Real Estate Deals.” Amy Fontielle. Investopedia

Picture by Michael F. McElroy for The New York Times.