A contract for deed, also known as a land contract or an installment sale, is one type of owner financing. Owner financing contracts can be written in ways favorable to the owner, like lease options, or in more buyer-favorable methods like an owner-carried mortgage. Contract for deed owner financing is a middle road that gives both the buyer and owner some protections.
Contract for Deed Mechanics
When you buy a house on a contact, you make monthly payments of principal and interest just like a mortgage. The interest is even tax-deductible as are the property taxes if you are the one responsible for paying them. However, you don't own the house. You get "equitable" title, which means that you have the right to live in the house, use it, and even sell it, but the original owner holds on to the legal title to the property. She transfers it to you when you make your last contract payment, which is frequently a balloon, and pay her off.
Contract for Deed Concerns
Contracts for deed carry risks for both sides. The seller takes the risk that the buyer won't pay her. If the buyer can't pay and doesn't maintain the house, the seller could end up getting a severely damaged house back. On the other hand, the buyer might not have access to a standard foreclosure proceeding to protect him if he can't pay. The buyer also usually needs to eventually get permanent financing, which could be problematic if he hasn't repaired his credit.
The lease option or rent-to-own transaction typically favors the seller. In this transaction, the "buyer" rents the house from the seller. In addition to the rent, the buyer pays an extra amount that gets applied to the cost of buying the house. At signing, buyers usually also pay an option fee that reduces the home's purchase price. If everything goes well and the "buyer" eventually purchases the home, he'll get the benefit of using the money he's accrued to buy the house at the locked in price. If he can't use his option, though, the seller usually keeps all of the extra money that he paid.
The seller can also choose to carry a mortgage for the buyer. These transactions work just like regular home sales, but instead of using a bank for the mortgage, the buyer borrows from the seller. In these transactions, the buyer holds the title to the property, and the seller just takes the position of a bank. If the buyer doesn't pay, the seller can take the home, but she'll have to go through the same foreclosure process as any other lender.
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