Owner financing, C/D, land contract, bond for deed – you may have seen these terms while browsing for land and wondered what they mean. All those terms refer to an alternative financing option known as a “Contract for Deed” or “CD”. In this article we’ll explore what a CD is and what the advantages and disadvantages are for both the buyer and seller.
What is a Contract for Deed?
A CD is a formal agreement or contract between a land owner (seller) and a buyer where the seller finances the purchase of the property for the buyer. This differs from traditional finance options where a third party such as a bank or credit union lends the money to purchase the property to the buyer. Instead the seller takes payments from the buyer directly. Although CD’s are usually open to any terms the buyer and seller agree to, there are several which are typical. These are usually a set length of the CD (such as 5 or 10 years), a down payment in cash, an interest rate, and a monthly payment. Unlike a mortgage, while the buyer takes possession of the property at the beginning of the contract, the seller retains the deed to the property until the contract is fulfilled at which time the deed is transferred to the buyer.
What are the benefits of a CD?
CD’s are very flexible when they are drafted. It is up to the buyer and seller to determine what goes into the contract rather than a bank underwriter. Often this means that a person who wouldn’t ordinarily qualify for a mortgage can buy a property. It also means that some other hurdles to conventional financing, such as an inspection or appraisal, do not necessarily need to be dealt with. For sellers this can open up another pool of buyers for their property leading to a quicker sale.
What are some of the downsides of a Contract for Deed?
Many CD’s have payments which do not amortize the purchase price over the length of the CD. This means that unless a buyer makes extra payments, there will be a large lump sum due at the end of the contract. This is often referred to as a “balloon”. For example, buyer John and seller Sam enter into a contract for deed for 40 acres of land. They agreed upon purchase price of the land is $10,000. The contract calls for John to make monthly payments of $100 to Sam for 5 years at which point the contract ends and John has to pay Sam whatever remains of the $10,000. Assuming John has made all of his payments at the end of 5 years, he would have made 60 $100 payments of $6000, he still owes Sam $4000 and will have to make that “balloon” payment to Sam in order to fulfill the contract. (For the sake of simplicity, this example leaves out an interest rate and down payment) Often, buyers refinance the property with a conventional mortgage to pay off the balloon.
If a buyer defaults on a contract for deed (misses scheduled payments), the seller could begin forclosure pro
ceedings immediately. Many of the consumer protections that exist for mortgages do not apply to contract for deeds including time periods a buyer would be allowed to catch up on payments.
For a seller, downsides include not being able to collect the full purchase price at closing time, and having the responsibility of servicing the loan (collecting payments). Also, should the buyer default on the contract and the seller is forced to foreclose, the property may not be in the same condition as when it was sold.
For both buyers and sellers, there is the danger of entering into a financial arrangement which they don’t fully understand. You should always consult a real estate professional and/or a real estate attorney before entering into a contract for deed regardless of whether you are the buyer or seller.