For most real estate transactions, the path to closing is often straightforward. A buyer hires a realtor, makes an offer, and if the buyer needs financing, they apply for a mortgage. At closing, the bank sends in the mortgage funds to the title company, the buyer signs all the mortgage paperwork (no simple task!), and the seller walks away with their check, paid in full, and the deal is done.
Sometimes, however, a buyer will not qualify for traditional financing. What alternatives exist if a seller wants to sell to a willing buyer, but the buyer simply cannot procure traditional financing to make the closing happen? One option is the “Contract for Deed.”
A Contract for Deed is a contract for the purchase and sale of real estate under which the purchaser acquires the immediate right to possession and the vendor defers delivery of a deed until a later time to secure all or part of the purchase price. In effect, the Seller becomes the “bank,” and in turn, promises to convey the property at a later date, once the contract if paid in full. Until the contract is paid in full, the buyer does not own the legal title to the property at all, but merely has an equitable interest and a right to possession of the property pursuant to the terms of the contract.
A Contract for Deed carries significant risks for a buyer. While a mortgage will often take many months to foreclose, usually followed by a 12-month period in which the owner can “redeem” the foreclosure, a Contract for Deed in default can be quickly cancelled by the seller, often with only 30-90 days’ notice. If that 30-to-90-day foreclosure period passes without the buyer curing their default, the contract is cancelled, and the buyer forfeits their downpayment, all subsequent payments, all improvements made to the property, and any appreciation gained on the real estate over the course of the contract. Because the Contract for Deed does not involve an extension of credit, few legal protections normally available for consumer borrowers are available. In short, if the contract is cancelled, the buyer is often left with nothing, and has no further opportunity to “redeem” or get the property back.
Optional language can increase the risks further for a buyer – for example, an “alternative acceleration remedy” may provide that, if one payment is missed, the seller can call the whole principal balance due as one lump-sum payment, often putting the buyer into the impossible position of needing to come up with many thousands of dollars on short notice or lose the property entirely.
Contracts for Deed have a troubled past and have often been a useful tool for predatory lenders. For example, from 1934 through the 1960s, the Federal Housing Administration (FHA) encouraged the practice of “redlining” neighborhoods to identify “mortgage risks,” often with racially disproportionate impacts. The FHA would not insure mortgages in certain districts, which were often core urban neighborhoods or African-American majority neighborhoods, shaded red on the official maps. Banks would often not grant mortgages for homes in these “redlined” areas. Left without banks willing to lend, buyers who wished to purchase homes in redlined neighborhoods were systematically forced to turn to more risky alternatives like the Contract for Deed. A Duke University Study[1] found that the African-American community in Chicago alone lost between $3.2 billion and $4 billion in wealth through contract for deed forfeitures before the practice of redlining was abolished in 1968.
While the formal practice of redlining is behind us, Contracts for Deed remain a risky alternative to traditional mortgage financing, and any buyer will likely have more legal protections getting a mortgage rather than entering into a contract for deed.
Contracts for Deed remain attractive, however, in certain situations. If Seller is having troubling selling a parcel of real estate, they might be willing to accept payments over a period of time from a buyer with poor credit, rather than wait for another buyer to come along. Contracts for Deed remain a useful tool to sell real estate intergenerationally, between parents and their children or other close relatives, particularly where a younger buyer lacks a good credit history, and especially where it is unlikely a seller is going to try to take advantage and aggressively foreclose on a buyer who is a friend or relative. If mortgage rates rise, the use of the contract for deed may also increase as more and more prospective homebuyers are priced out of the market.
The Minnesota Legislature has recently enacted significant changes to the Contract for Deed statutes to protect residential homebuyers purchasing on a Contract for Deed. Among other things, contracts for residential real property must now disclose if the seller is an “investor seller” – i.e. a person who has purchased the property as an investment property. Any cancellation of a contract for deed by an investor seller now gives the buyer 90 days in which to cure their default. An investor seller must now also provide a detailed disclosure prior to entering into the Contract which clearly discloses any balloon payments which will come due on the contract, the amount that the investor seller (or a related party) paid to acquire the property in the first place, and an investor seller must provide a detailed amortization schedule.
Where a seller has an underlying mortgage which has a “due on sale” clause, the seller must also secure the consent of their bank prior to entering into the contract. Residential purchasers now also have a 10-day “cooling off period” after receiving all disclosures in which they can cancel the contract. Finally, a buyer who cancels their contract within four years of the purchase can also recover a portion of their downpayment, and if an investor seller cancels a contract within the first four years, the buyer must be refunded any portion of their downpayment which is more than 10% of the overall purchase price.
While the new changes to the Minnesota Contract for Deed laws are likely to help protect prospective homebuyers from unjust forfeitures, they also present new legal challenges to ensure that Contracts for Deed are drafted and entered into properly. Any buyer or seller considering using a contract for deed should seek out competent legal advice to ensure they are in compliance with the new law.
[1] Samuel Dubois Cook Ctr. on Soc. Equity at Duke Univ., The Plunder of Black Wealth in Chicago: New Findings on the Lasting Toll of Predatory Housing Contracts 6, 8 (Sharon McCloskey & Bruce Orenstein eds., 2019).
