Americans who do not qualify for a conventional mortgage but still want a house to call their own sometimes opt for a thinly regulated financial arrangement called a contract for deed. In these deals, the sellers function like lenders. They collect an initial down payment and then monthly payments.
getting equity out of home when contract for deed
And while attorneys general in states in the Northeast and Great Lakes region have gone after large-scale contract for deed or rent-to-own sellers who use deceptive tactics, attorneys general in the Midwest do not often take enforcement action.
A 2019 study by the Joint Center for Housing Studies of Harvard University outlines an earlier era of contracts for deed in Chicago, where blockbusting and redlining depressed home prices in the 1960s and 1970s. Investors used contract sales to sell properties at inflated prices with high interest rates to people who could not get a conventional mortgage.
George, who co-authored the Harvard study, said lenders rarely underwrite loans in low-income communities where homes are priced at less than $100,000 and often need repairs. So contracts for deed sometimes fill the void.
While never ideal, lawyers and experts say contracts for deed can be one of few options for some real estate transactions. Buyers who lack credit history, have damaged credit or who cannot make a down payment often do not qualify for a loan from banks or mortgage companies.
Echoing the Harvard findings, the Joint Center for Housing Studies says traditional mortgage companies are reluctant to make loans in distressed neighborhoods, leaving seller-financed loans or a contract for deed, the instrument of last resort.
Michael Duffy, a semi-retired attorney who has handled dozens of cases involving abuses of real estate contracts, said in spite of the risks, contracts for deed can be useful with responsible sellers.
Iowa tightened some of its land contract laws after a 2003 scandal involving the Wolford Group, a family enterprise accused by the Iowa Attorney General of committing fraud when it bought and sold homes under risky land contracts.
Prospective homeowners who can't qualify for a home loan are often desperate to find options that don't involve a bank or mortgage lender. An alternative called contract for deed started booming after the housing bubble popped in 2008. But homebuyers beware - the arrangement can be a risky one. Steve Vockrodt of the Midwest Newsroom reports.
STEVE VOCKRODT, BYLINE: Most people who buy a house simply apply for a mortgage and close on the property they want. That's the last time they deal with the seller. But some who can't qualify for a loan opt for another method of financing a house purchase, where the seller basically also acts like the lender. Contracts for deed and similar transactions, like renting to own, are thinly regulated in most states, and they often don't result in the buyer actually owning the home.
VOCKRODT: Contracts for deed and similar arrangements, like renting to own, happen all across the country, and it's hard to get precise data because they're not regulated the way mortgages are. The way these deals often work is the seller collects a down payment and then gets monthly installments. The buyer is usually on the hook for taxes, insurance and any repairs. And unlike a mortgage, it's the seller who holds onto the title until the house is paid off. That means if a buyer falls behind on their payments, sometimes even one installment, the seller can reclaim the property, leaving them with no equity and losing any money that they spent in proving the property. Many of these houses are in poor condition and in low-income neighborhoods.
SARAH MANCINI: The buyer is being told they have all the duties of homeownership, but they don't get the protections of a right to a foreclosure, and they don't have a deed, and they don't have a right to sell the home and realize the equity.
VOCKRODT: Though she was confused by the terms of the contract, she signed it and made an $8,000 payment, thinking she'd just bought the house. Within months, she was evicted for not making monthly payments. Following the housing crash of 2008, Wall Street-backed firms bought up thousands of foreclosed or abandoned properties on the cheap to sell using a contract for deed arrangement. Some are facing lawsuits, accusing them of trapping buyers into predatory contracts that are designed to fail. As foreclosures are on the rise again, housing advocates worry that these risky contract for deed arrangements will again become a popular but risky last resort for prospective homeowners.
To determine the value of the home, the lender will use the original agreed-upon home price or the appraised value, whichever is less. That applies if the land contract was recorded within the most recent 12 months.
After getting into the home, take the next 12 months to fix the income, credit, or property issues that made owner financing your best option in the first place. This could make the traditional refinance a smooth and successful process.
If the equity exists, there is no need for down payment when you refinance, because you already own the home. If you have at least 20% equity, you can avoid mortgage insurance payments, saving more money each month.
When the economy is down, mortgage lenders tend to become more selective when lending money. Tightened home loan standards can make it difficult to qualify for a mortgage. For those who can't qualify for a mortgage or just don't want one, contract-for-deed and lease-to-own options exist. Both home-purchase options come with advantages and disadvantages.
A contract for deed, which is more readily known as a land contract, is a formal contract that exists between a home's seller and its buyer. When a contract for deed is executed, the seller agrees to allow the buyer to pay off the home in installments. In a contract for deed, the seller continues to retain title to the home while the buyer holds what's called an equitable title.
Lease-to-own agreements require that part or all of the rent paid by renters be applied to their home's final purchase price. Under a lease to own, a seller sets a home's final purchase price when the agreement is finalized. Renters under lease-to-own agreements have an exclusive option to buy their homes for a specified time. On the other hand, in rent-to-own agreements, renters aren't legally obligated to purchase the homes they're renting.
Contract-for-deed and lease-to-own agreements both feature less paperwork than what's found in traditional mortgages. Also, buyers with weaker credit or little money to put down can benefit from contract-for-deed and lease-to-own programs. Under a lease-to-own home-purchase agreement, the landlord still can maintain control over her property. Finally, a contract for deed really does confer a small degree of equity in the home to its purchaser.
Buyers under lease-to-own agreements are renting the property for a time. Additionally, under a lease to own you'll need the landlord's permission to make any property improvements. In a contract for deed, a seller is financing his buyer's purchase and only collects monthly payments, not the lump sum. When a buyer in a contract for deed defaults, the seller has to do all the legal work in enforcing its terms or voiding it altogether.
Tough economic conditions tend to bring out real estate scam artists. Unfortunately, both contract-for-deed and lease-to-own programs enable unscrupulous scams. For example, a seller in a contract for deed could attempt to void the entire contract if even one payment is missed. Never sign a contract-for-deed or lease-to-own agreement without thoroughly reading and understanding its terms and conditions first.
All of these arrangements fall under the rubric of alternative financing, but the required contractual provisions and applicable consumer protections for each vary widely from state to state. In general, research has shown that alternative arrangements are associated with higher long-term costs, less favorable contract terms, and an increased risk of losing home equity compared with commensurate mortgages.12 2ff7e9595c
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