Contracts for Deed: Not Your Typical Rent to Own

Folks regularly think they want to enter into a “rent to own” agreement when what they are more appropriately looking for is a contract for deed.  A rent to own agreement is basically a lease where the payments are applied to a reduction in purchase price on an option to buy real estate in the future.  A contract for deed is an actual transfer of property, where the contract for deed seller (or vendor) transfers almost all of his property rights to the purchaser (or vendee). It is an excellent option for both buyers and sellers who choose seller financing.  The statutory rules for contracts for deed in Minnesota can protect both the seller and purchaser.

A contract for deed is sometimes called a “land contract” or “installment land contract.” In a contract for deed, the seller, rather than a bank, finances the purchase of the property. The purchaser takes immediate possession of the property and agrees to pay the purchase price of the property in installments. The seller retains the legal title to the property until the last payment is made and the contract is fulfilled and then a second closing occurs where the final deed to the property is transferred.

Benefits to the Purchaser – Especially in today’s economy, contracts for deed are  attractive to purchasers who might not otherwise qualify for a loan. The purchaser may also be able to purchase the property with a relatively low down payment because there is no requirement for the typical 20% down. In the event of a default in payments, the statutory scheme allows a 60 day period of time for the purchaser to bring payments current (along with some other minor charges) to reinstate the contract. Contracts for deed can also be faster and less costly to finalize than traditional mortgages: mortgage origination fees and application costs are nonexistent.

Risk to the Purchaser – There are still risks to a contract for deed purchaser. Because the seller keeps the legal title to property until the contract price is paid in full, the buyer does not become the owner of the property until he completes his payment obligations and receives the title from the seller. If the buyer defaults on the contract, the buyer runs the risk of losing all of the money that he has paid on the contract, this would include amounts paid for a down payment, monthly installments and any improvements to the property.

Benefits to the Seller – In today’s real estate market and economy a contract for deed is also attractive to many sellers– by selling on a contract for deed you can market yourself to a wide variety of potentially buyers who would not qualify for traditional financing (this of course brings the risks discussed below).  A contract for deed can be more favorable than other seller financing vehicles because the contract cancellation procedures are set by state law. In general, if the buyer defaults on an installment, the seller can cancel the contract, retake the land, retain the payments made and benefit by any improvements that have been made on the premises by the purchaser.  This process can take as few as 60 days. The seller may do this without a foreclosure sale or judicial action.

Risks to the Seller – Contracts for deed also places risk on the seller. Seller’s must remember that they are effectively acting as both a landlord and a bank.  You must be diligent in collecting payments and recognize that you may end up with the property at the end of the day.  And in doing so, although the purchaser has an obligation not to commit waste on the property, you cannot control what is occurring on your property when in the possession of the purchaser. Similarly, although the seller is acting like a bank your “underwriting” standards are not the same as many banks.  Although you can ask for copies of financial statements and credit reports, you must remember you are taking a risk as to the quality of your purchaser.

Both sellers and purchasers must remember a contract for deed is still a contract and many of the rights and remedies of the parties are based solely on the provisions contained the actual contract for deed (other provisions are controlled by statute). Provisions such as the time, the place and the amount of payment indicate the continuing contractual relationship between the parties.  Contracts for Deed need to be recorded in the County Records and upon cancellation or satisfaction either a cancellation or a deed needs to be recorded.  It is also important to do proper title inspections and understand the implications of due on sale clauses as it relates to existing mortgages on the property. As a result is important for both buyers and purchasers to seek the advice of an attorney to not only assure that the contract is prepared properly, but that each party understands the transaction completely.

A contract for deed can be a cost-effective and relatively safe way for both sellers and purchasers to enter into seller financed agreements.  If you are exploring the possibility of buying or selling property on a contract for deed, please consider contacting the attorneys of Bloomgren Hanson Legal to further discuss your particular facts and needs.

Please also see our previous article on seller financing in the form of notes and mortgages: Are You Crazy to Consider Seller Financing?