What is a contract for deed?
What is a Contract for Deed?
As a contract for deed, or CFD as they are often called, is a type of real estate financing option, definition and description of it can be muddied. Many people understand the term "contract" whether that’s a real estate purchase contract or a simple loan agreement, but the contract for deed is neither. A CFD offers a seller financing option that is used by sellers whenever conventional financing isn’t available or when the seller is looking to sell quickly. In a CFD, the buyer agrees to make installment payments over a set period of time until the purchase price is paid off, at which time the seller transfers the property title to the buyer. One of the greatest benefits of a CFD is that title doesn’t transfer until the last payment has been made. During the purchase period, the actual owner remains the seller. The seller will record the contract with the county clerk’s office where the property is located, securing a legal right to the property until the buyer’s obligations to the contract have all been met. As long as the buyer makes payments on time, he/she can use and possess the property just like a traditional homeowner would. This means the buyer can also build equity in the property, despite not yet having full ownership of the home.
A CFD is beneficial for both buyers and sellers. Since the seller holds onto the title, they can repossess the property if the buyer fails to make payments. Sellers can usually sell their homes more quickly since the majority of buyers will not need to wait on the bank to approve a loan and can bypass the lengthy process that comes with it. Additionally , sellers don’t have to worry about the buyers’ credit history, making it easier to sell to people who otherwise wouldn’t qualify for a mortgage agreement. In Texas, a CFD is similar to a traditional mortgage agreement with a few minor differences. Like with a mortgage agreement, a seller can sell his/her home, but while the buyer is making payments to the seller, the seller holds onto the title to the home. Like a mortgage, the buyer has time to repay the loan, rather than paying the full amount at once. Unlike a mortgage, which usually takes about 30 years to pay off, a CFD typically has a 3 to 5-year time frame. Also, the closing costs for CFDs are much lower than traditional mortgage agreements because there are no closing fees associated with a bank as there would typically be. That said, a CFD isn’t without its disadvantages. Tax liability falls on the sale of the property, so the seller is responsible for capital gains tax. This can be a large sum of money on a fast appreciated property. Second, the buyer assumes the risk of the maintenance, repair, and mortgages. While a CFD can be seen as a great financing option for selling your home quickly, ask yourself the following questions: If you’ve decided that a CFD is the right way to secure financing for your home purchase, consider the following: If you’re familiar with IDEA (Improving the Delivery of Equal Access to Justice) 4C3K: File the form complaint for a breach of contract for deed, also known as a "contract for deed" or an "installment contract" or an "article of agreement". Formerly known as a Vendor’s Lien Contract.
Legal Basis for Contracts for Deed in Texas
Contracts for deed in Texas are primarily governed by statutory law. The Texas Property Code, beginning in Section 5.061, sets out the legal framework for contracts for deed. The statute defines a contract for deed as an agreement under which the owner of real property sells the property to a purchaser and retains title to the property until a specified performance has occurred, in this case, the buyer’s payment of the purchase price.
The main provisions of the statute which govern contracts for deed attempt to provide consumers some measure of protection: While these provisions exist, they are often ignored. Mortgage lenders are not required to comply with the statute and many real estate agents have no idea what the statute requires. Common violations of the statute include:
Under Section 32.41 of the Texas Penal Code, any violations of the Contract for Deed statute can result in criminal fraud. In other words, a consumer who is cheated by a seller may end up with a remedy in a civil lawsuit and a remedy in a criminal lawsuit against the seller.
Advantages and Dangers of Contract for Deed
There are both benefits and potential difficulties with using a contract for deed. One reason that it is an appealing option to some buyers and sellers is that the monthly payment may be more affordable than a mortgage payment, especially in the current credit market. Typically, a contract for deed also involves less paperwork and does not require an appraisal. From the seller’s side, selling on this type of agreement often means that the seller can get some immediate money down and a regular monthly payment which will help to finance the transaction. It is important to note, however, that the seller remains the owner of the real estate, and retains certain obligations until the buyer pays off the full amount of the balance and obtains the title to the property.
That said, there are real downsides to this type of agreement as well. For one thing, the seller is responsible for homeowner’s association fees, property taxes, and maintenance of the property during the contract term. From an investment perspective, the seller could lose out on possible appreciation of the property if it becomes part of the buyer’s protected bankruptcy estate. Additionally, the buyer does not obtain the benefits of depreciation expense on the property during the contract term.
For the buyer, the biggest drawback is that even though this arrangement is generally treated as a purchase and sale of real estate for tax purposes, some consider it as a lease with purchase option agreement which falls under the Residential Leasing Act. To qualify as a lease, the buyer must have possession of the property and be responsible for paying all expenses, including paying the property taxes and maintaining insurance. If the buyer fails to maintain insurance or the property taxes, this could result in the buyer losing the property and/or owing a judgement against them if the property is sold for less than the amount owed.
In summary, if possible, this arrangement is best suited to a turnkey property in which there is no possibility of litigation with tenants or other disputes which might lead to the property being sold for less than the amount owed, and to a buyer who has more income than expenses and thus will qualify for a homestead exemption on the property.
How to Draft a Contract for Deed in Texas
To create a contract for deed, there are several important steps that must be completed.
While it is a good idea to do some preliminary research before entering into a contract for deed, the process actually begins with negotiations between the seller and buyer. In Texas, there is no standard form or court-prepared contract for deed. This means that the seller can either attempt to write the contract for deed themselves (which I do not recommend as this is one of the most common mistakes in contracts for deeds), or they can find one online, purchase one, or have an attorney prepare one.
Once the contract for deed is created, it should contain the full legal description of the property, or at least the volume and page number if in the county clerk’s office. The total price and principal should be listed. A contract is not a loan and Texas law has held that the purchaser is treated as the equitable or true owner of the property and has an equitable interest in the proceeds of sale, not a mere license or option to purchase. The buyer should have an earnest money provision providing that their earnest money deposit should be returned if the title is not good or it cannot be closed through no fault of the buyer.
The down payment should be listed including a list of the documents to be presented at closing to effectuate the contract for deed. A provision should be stated that the seller will be responsible for conducting the Closing through a closing agent or attorney of the seller’s choosing, including the provision for the seller to have a lender’s title policy issued at their cost insuring the lien of the buyer.
Perhaps the most effectual portion of the deed is the promise by the seller to transfer the property to the buyer once the buyer pays the contract for deed in full. It should always provide for acceleration of the unpaid balance in the event of default. Last but certainly not least, there should be a provision that provides for attorney’s fees should litigation arise.
Common Issues and How to Avoid Them
Contracts for deed are not without their risks, and either party could find themselves at a disadvantage if care is not taken in the drafting and execution of the documents. Here we will look at some common mistakes and issues arising in contracts for deed and how they can be avoided.
No Title Insurance or Warranty Deed Provided
Since the deed would be transferred only after all payment has been made, does a contract for deed need to issue title insurance? The answer is yes, the purchaser should take care to obtain a title insurance policy of the real property, just as they would in a typical home purchase. This is because title problems can arise at any time, and the seller may not be aware of existing covenants or restrictions against the property. The only way to avoid potential liability is for both parties to obtain title insurance so that the title is guaranteed and any loss covered by the insurance policy.
In addition, a warranty deed should be provided to the purchaser so that any previous owners of the property are obligated to perform in the event that any defects or blemishes occur with the title.
Extremely Long Loan Terms
While contracts for deed are typically arranged with a 30-year loan term , there are instances when the loan term is extended out to 50 years or longer. From a mortgage financing perspective, an unusually long term will put the risks on the lender if a default occurs, since it is likely the property will have depreciated significantly by the end of the term. If the value of the property depreciates faster than the loan, the lender will likely find themselves with a home that has far too little equity to make it feasible to foreclose on the property. A typical loan terms is around two-thirds the number of months until the borrower reaches retirement age (assuming the borrower retires around age 68).
Vague Payment Terms
Contracts for deed are much like a traditional offer for purchase of a home – they should clearly outline the loan repayment schedule and terms. It is important that these details be explicitly stated otherwise the seller may be held liable by the court for an amount greater than that which was intended. It is recommended that a contract spell out the dates, amounts and frequency of the payments in addition to the required payment at the end of the term.
Any dispute that arises in respect to the contract should be resolved through arbitration rather than litigation. The contract should contain a provision that each party agrees to submit to the jurisdiction of the arbitrator.
When Can a Contract for Deed Be Terminated?
Termination of a Contract for Deed and Related Issues in Texas.
Contracts for deed can be terminated like most other contractual relationships. In the event of a default by the buyer to make payments under the contract, the seller has several remedies. Default Fortunately for sellers, when the buyer generally defaults on under the contract terms, sellers can typically terminate up the contract with little obligation (outside of simply selling the property). However, in many cases, the buyer can eventually remedy the default even after a termination has been issued (e.g., a late payment). Foreclosure of a Contract for Deed In Texas, a seller may elect to foreclose on a parcel of land sold under a contract for deed without securing a judicial judgment. Depending on the circumstances, the foreclosure process requires a notice of foreclosure to be posted on the front door of the residence being sold, or at the courthouse where the sale is set to be conducted. The posting process requires the seller to have the notice clearly affixed to the front door of the residence being sold and also filed with the clerk of the county. In addition, the seller must publish a foreclosure advertisement at least 30 days before the foreclosure sale is held. Failure to comply with the foregoing requirements could result in the voiding of the foreclosure. Post Default Dispute Resolution Processes When disputes arise after the default, the parties have several options: 1. Seek an agreement between seller and buyer (most favorable option). 2. Dismiss the contract for deed in favor of seeking other forms of agreement or action (judicial action, quit claim deed, or seller files suit in Justice or District Court). Property sold under a contract for deed is treated like other secured loans. Under certain circumstances, the seller has specific remedies against the buyer for breach of the contract.
Challenges of Contracts for Deed in Texas
Last year the Texas legislature created a new law that allows contracting parties to use "amortized contracts for deed," which mitigates some of the risks faced by homebuyers under the traditional contract for deed model. Following the lead of other states, these amortized contracts for deed afford more security to homebuyers in the event of a default, which may make them a more attractive option moving forward.
For example, under an amortized contract for deed, the buyer would be entitled to a refund on the payments made towards the purchase of the home in the event the buyer is terminated from the contract. In contrast, under a traditional contract for deed, the homebuyer usually loses all rights to the property and the money they’ve put down. A notice must first be sent before default can be declared, which gives the homebuyer time to resolve the payment issues before being forced into default. Additionally, under a standard contract for deed, the seller is required to give the homebuyer one year to cure whatever issue caused the breach of contract which usually turns out to be missed payments . Under an amortized contract, aside from the one year to cure any payment issues, the buyer is also entitled to liquidated damages in the amount of three months’ worth of the agreed upon interest rate. So for example, if you agree on a 7% interest rate on a $100,000 contract, and you fall behind in your payments, you are entitled to the sum of $2,500 as opposed to losing the home and all the funds you’ve put in.
Additionally, if the homebuyer defaults on the contract, the seller must provide a notice for 30 days to allow the homebuyer to cure the breach before foreclosure. This gives time for the buyer to remedy the issue and save their dream home. Because of all these benefits, an amortized contract for deed may prove to be beneficial across the board for both sellers and buyers. Sellers will get their money and buyers will get to keep their home. Overall the future of contracts for deed looks promising, especially with the introduction of these amortized contracts which take one step further in protecting homebuyers from unscrupulous sellers.