What is a Contract For Deed? - Definition & Procedure

Instructor: Shawn Grimsley
Sometimes a real estate purchaser cannot obtain conventional financing but a seller may be willing to finance the transaction through the use of a contract for deed. In this lesson, you'll learn about how a contract for deed works.

Contract for Deed Defined

Let's say that you want to buy a house, but you have a problem - you can't qualify for a traditional home loan. Are you out of options? Not necessarily. One solution is a contract for deed, sometimes referred to as a land sale contract or land contract. In traditional bank financing, you obtain a loan from a lender that is used to buy the property in one lump sum payment and you get a deed to the property immediately. However, in a contract for deed the seller agrees to allow you to pay for the real estate through installments instead of in one lump sum. The seller will continue to hold legal title to the real estate until the final installment is made. At that time the legal title will be conveyed to you by deed.

Contract for Deed Basics

The terms of a contract for deed can vary significantly from contract to contract. However in general, to comply with the statute of frauds, every contract must be in writing and signed by the parties to be bound - in this case, both the vendor (the seller) and the vendee (the buyer). A smart vendee will insist that the signed contract be then recorded in the land records office in the county where the property is located. (Recording the contract provides public notice that the buyer has an interest in the real estate.)

Contract for Deed Payments

The contract for deed will contain provisions regarding payment. The contract will identify any down payment required and list the total principal due as well as the applicable interest rate. A schedule of fixed principal and interest payments will also be included. A balloon payment is often required in a land contract. A balloon payment is a large payment due at the end of the payment period. For example, the contract may provide for 59 monthly payments of $1,000 with a balloon payment of $101,000 due on the 60th month. Many buyers can't afford to pay the balloon payment out of pocket and will plan to refinance the purchase with a traditional mortgage loan at that point. (This can be risky for the buyer, not just because of the new financial strain of the mortgage loan but because final payment to the vendor may be delayed. Mortgage transactions can take several months to complete.)

The buyer will usually be responsible for insurance and payment of property taxes on the real property. Oftentimes, a land contract may provide for the insurance and property tax payments to be made on a prorated monthly basis from an escrow account.

The contract will also address default. If the buyer stops making his payments, a forfeiture provision will permit the seller to declare the contact forfeited.

Treatment of Forfeiture

Forfeiture can lead to arguably harsh and unjust results. If invoked and enforceable, a forfeiture provision in a contract for deed could declare that the defaulting buyer will lose the property and his past payments if he stops making payments. For example, a buyer who has paid $95,000 of a $100,000 obligation under the contract for deed could lose the property and his $95,000 if he was late on his payment. However, courts and legislatures in some states have started to be more circumspect about strictly enforcing forfeiture provisions depending upon the circumstances of the case.

States following this modern trend typically take one of two approaches. First, state law may give the buyer the same safeguards that a defaulting borrower has in a judicial foreclosure action on a defaulted bank loan if the court finds that the seller would be unjustly enriched by complete forfeiture. In our example above, if the property sold at a foreclosure auction for $100,00, the vendor will get the $5,000 owed and the vendee will get his equity in the property ($95,000) less the costs and fees related to the foreclosure.

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