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Beware toxic transactions: Homebuyers urged to be careful about contract for deed offers

12/14/2016 9:04:16 AM

SAINT PAUL – Maybe you have seen the signs on busy streets or the ads on the internet: “Don’t waste money on rent … Own a home even with bad credit ... Easy owner financing available.”

It likely means someone is trying to sell a house on a “contract for deed.” Although promising the dream of homeownership, it can too often end up as a financial and personal nightmare for unsuspecting buyers.

“A contract for deed is a financing arrangement that poses many serious and costly risks for homebuyers,” says Minnesota Commerce Commissioner Mike Rothman, whose agency regulates the real estate sector. “A contract for deed does not include the consumer protections available under state and federal laws for traditional mortgage financing. These have been called toxic transactions because buyers can lose their homes and all the money they paid to own them.”

A contract for deed lets a buyer purchase a home without a mortgage. The buyer instead agrees to directly pay the seller in installments, while the seller retains legal title to the property and actual ownership passes to the buyer only after final payment.

Contracts for deed have long been a financing option for property transactions between family members or friends. Some nonprofit housing organizations also use them to help low-income families find a path to homeownership.

But in the wake of the 2008 financial crisis, some real estate investment companies have bought up foreclosed homes and then offered them on contract for deed to low-income buyers or those with poor credit scores who cannot secure traditional mortgage financing.

Contracts for deed are also a favorite trick used by real estate scammers who will either “churn” a property through multiple would-be homebuyers or collect payments from a buyer while letting the property go into default with an unpaid mortgage.

While a contract for deed can sometimes benefit a buyer with no other avenue to homeownership, it is a high-risk option that is subject to abuse and predatory practices. Many buyers with contracts for deed never become full owners of the property and lose the payments they made.

With a contract for deed, buyers often do not fully understand the extent of their obligations, all of the costs they must pay and the risks they are incurring, including how quickly they can lose the home and all the payments they have made.

For example, in addition to making monthly payments to the owner, a buyer must pay for homeowners insurance, property taxes and repair and maintenance costs. If the buyer fails to keep up to date with any of these, the contract can be canceled and the buyer can be quickly evicted by the owner.

Also, after a specified period of time, a contract for deed will typically require the buyer to make a large lump-sum “balloon payment” to pay off the full price of the property. If the buyer is unable to obtain a mortgage or otherwise make this balloon payment, the seller can cancel the contract, evict the buyer and keep all the payments that have already been made. 

Here are some important tips if you are considering buying a home with a contract for deed:

Apply for a conventional mortgage. Instead of jumping at a risky seller-financed offer, you should first try to qualify for a conventional mortgage loan from a bank, credit union or other licensed mortgage lender. It will include more consumer protections and likely cost you less.

Get advice. A contract for deed is a complex arrangement with many legal and financial risks. Consult with a lawyer or a certified housing counselor so you understand the pros and cons of a contract for deed in your situation. 

Get an independent appraisal and a professional inspection. An appraisal will tell you how much the property is worth so you do not overpay. An inspection will tell you about the property’s condition and what repairs are needed. Also check with the local housing inspection office about any reported code violations that require repairs.

Make sure you understand the contract and your financial responsibilities.  Review the monthly payment, property tax, insurance and maintenance/repair requirements you are accepting. What interest rate are you paying? How much is the balloon payment and when is it due? What are the terms under which the seller can cancel the contract and evict you?

Research the property title. Make sure the seller really owns the property. You risk losing the home and everything you have paid if it has a mortgage and goes into foreclosure. Check with a title agent or the county property records office to find out if there is a mortgage or other liens on the property. A title agent can also ensure the contract is properly recorded with the county, as required by state law.

Commerce is here to help

Contact the Minnesota Commerce Department’s Consumer Services Center by email at consumer.protection@state.mn.us or by phone at 651-539-1600 or 800-657-3602 (Greater Minnesota).

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