Some of the Risks with a Contract for Deed

Without a doubt, one of the best things about the MAREI meeting is how Kim brings in varying people to speak about different topics in real estate investing. Sometimes it’s a national speaker who sells professional training courses. Other times its a local investor who talks about what they are doing in the market, such as buying or selling properties on a contract for deed. It’s always something new and there is also something to learn even if it’s a small tidbit that someone says or something not to do that’s talked about during the meeting.

With that being said, there is only so much that can be discussed in a couple of hours, and just because something works for one person, that doesn’t mean it will work for everyone.

That brings me to last night’s meeting that talked about contracts for deeds or land installment contracts. For those of you that are new to this area, a contract for deed is an agreement where a seller agrees to purchase real estate from a buyer; however, instead of transferring title to the buyer at the time of the sale and the buyer paying the full purchase price to the seller, the buyer agrees to make payments to the seller over time and the seller remains the owner of the property until all of the payments are made.

The History of Contracts for Deeds

These types of agreements are nothing new and have been around for many, many years. There are court cases involving contracts for deeds that go back to the early 20th century and they may go back either further than that. A 2019 Harvard Study noted that contracts for deeds gained particular momentum in the 1960’s and 1970’s by being marketed as a way for people of color to purchase homes in light of the redlining taking place at the time that made it difficult for those Americans to obtain mortgages; however, many of these contracts were designed to fail so that the seller took back the property after receiving large sums of money from the buyer.1 ANN CARPENTER, TAZ GEORGE, AND LISA NELSON, The American Dream or Just an Illusion? Understanding Land Contract Trends in the Midwest Pre- and Post-Crisis, August 2019, chrome-extension://efaidnbmnnnibpcajpcglclefindmkaj/https://www.jchs.harvard.edu/sites/default/files/media/imp/harvard_jchs_housing_tenure_symposium_carpenter_george_nelson.pdf. Because of some of the risks from contracts for deeds, there is currently a bill before the Kansas legislature to make changes to some of the laws related to these types of contracts.2HB 2322; http://www.kslegislature.org/li_2022/b2021_22/measures/hb2322/

This isn’t to say that all contracts for deeds are bad things or that all people offering them are dishonest or have selfish motives. One of the speakers last night, Luther Wilson III, has been doing these deals for many years and is very kind and generous when it comes to dealing with his buyers. Our office has closed some of his deals before and it was clear that he puts the buyer first and is providing an opportunity for homeownership for people who may otherwise be stuck with renting.

So you might be asking, what’s the point of this article?

The fact is that despite being a tool that may have a place in an investor’s toolbelt, a contract for deed is a very risky type of transaction for both the buyer and seller. That doesn’t mean you shouldn’t do it, but it does mean that its important that people listening to last night’s presentation understand the risks.

The remainder of this post is going to talk about some of those risk from both the perspective of the buyer and seller under a contract for deed.

Common Risks of a Contract for Deed to the Seller

One of the main reasons that proponents of contracts for deeds advocate for their use is because of the perceived ease of taking back the property in the event of default. Under most contracts for deeds, the agreement will state that if a payment is missed, the property is forfeited and the seller can file an eviction to remove the buyer from the property like a tenant.

This may be true if an unsophisticated buyer doesn’t know how to assert his or her rights and leaves the property voluntarily or does not contest an eviction action. With that being said, if the buyer merely mentions the fact there was a contract for deed in court, most judges will require that the buyer’s “equitable interest” be foreclosed upon through a court process.

What does all this mean? When a buyer has made a large contribution towards the purchase of a property — whether that be by a large down payment or numerous payments — most courts consider that person to have an equitable interest in the property. An equitable interest is a type of ownership interest in a property that means that the person has some claim to ownership despite not being the record owner of the property. The courts have held that it is not just for someone to lose an equitable interest (and the money they have invested in a property) without the right to come before the court. Moreover, in Kansas, the courts that handle evictions (limited courts, and magistrate judges) don’t have jursidiction or the authority to hear these type cases.

As a result, the action to remove the buyer is transferred from the eviction court to a regular civil court where it is subject to all of the normal timelines and delays of any other litigation. This means that the process may take a few months on the low end, and several years on the other. For example, I litigated a case as a lawyer that was initially filed as an eviction in March of 2016. It eventually went to trial a year later in March of 2017. The seller finally took back possession of the property, but not only was it an entire year, he spent thousands of dollars in legal fees to get to that point including on many hearings and disputes that wouldn’t have been present in a simple mortgage foreclosure.

The Kansas Court of Appeals talked extensively about some of the complications of litigating these cases in Barnett v. Oliver.318 Kan. App. 2d 672 (1993); https://law.justia.com/cases/kansas/court-of-appeals/1993/68-468.html

Legal costs and delays aren’t the only risks involved with contracts for deeds for sellers. As the legal owner of the property, the seller remains potentially liable for lawsuits, code violations, and other claims related to the property. For example, if there is a code violation on the property, the citation is going to be issued to the owner of record — not the contract for deed purchaser — as such, the seller may be responsible for fines for things the seller had no control over that took place on the property. If there is an environmental claim on the property, it will be the contract for deed seller that is responsible for any remedial actions or fines assessed by the environmental agency.

If the seller has existing financing on the property, the transfer of ownership via a contract for deed may invoke the due on sale close in their mortgage or deed of trust. Furthermore, if a seller does take back ownership of a property following a default by the buyer, the property may be in bad shape or worth far less than it was when the property was contract for deed was executed.

Common Risks of a Contract for Deed to the Buyer

There are also many risks to a contract for deed for the buyer. Many of these risks spur from the buyer not being on title to the property. For example, if after the buyer makes all of the payments under the contract, the seller refuses to transfer title, the buyer is forced to go to court to try to obtain ownership of the property.

For example, I litigated a case on behalf of a buyer under a contract for deed that made all of the payments except for potentially the last monthly payment (this was disputed and as the buyer paid cash, there was no record of if they did or didn’t make the payment). The seller then refused to deliver title to the buyer — even after they offered to submit a new payment for the last payment that was allegedly not paid — as the seller contended that the late or missed payment was a default that allowed them to take back the property despite the buyer paying over $100,000 in total payments over the life of the contract.

Like many contract for deed buyers, my clients did not speak English, and the seller did not speak their native language – Spanish. The buyers did not understand all of the documents they were signing and the contracts were drafted very favorably for the seller.

This matter ultimately went before the court for a trial, and my clients were able to get ownership of the property but not until spending thousands of dollars on legal fees and months of fighting about whether or not they would get to keep the property they had lived in for many years and paid well over the market value for in contract for deed payments.

The seller in the above example was obviously dishonest — or at least very greedy – but these type of issues can arise even with honest sellers. For example, what happens when the seller dies prior to making all of the payments?

I have seen this exact scenario several times before. The parties enter into a contract for deed and then the seller dies. The heirs obtain ownership of the property and know nothing about this contract for deed. Even if the contract for deed (or affidavit of equitable interest) is filed, they don’t have any record of payments nor know how much is owed. The buyer doesn’t know where to send payments so they end up behind and in default. The whole thing is a mess and the heirs may refuse to deed the property to the buyer or it may need to go through probate first. Additionally, if the seller had an existing mortgage that stayed on the property and the payments aren’t made (either after the death of the seller or because the seller has financial troubles), the buyer may be stuck with a large mortgage or deed of trust on the property that they would have to pay off to sell the property.

Finally, because the nature of the transaction and payment history is private, the buyer doesn’t build credit and can’t use the “equity” in the property for other loans.

The Bottom Line: Get Advice from a Professional

At the end of the day, the purpose of this post is not to scare you away from using a contract for deed for your purchases or dispositions. Instead, I think it’s important that everyone understands all of the risks of the transaction you are entering into and has professional advice. All real estate transactions come with some risk. It’s up to the individual investor to decide if that risk is balanced out by the potential gain from the transaction. This can only be done if you understand the risks of the transaction you are entering into.

This article is far from an exhaustive list of the risks (and benefits) of these type of transactions. This is why it is important that you find a lawyer you can trust and who can help guide you through not just the paperwork, but also the potential risks of your creative financing strategy. I know that everyone takes a lawyer saying you should hire a lawyer with a grain of salt, but that’s one of the reasons I stopped actively practicing law in 2022. I want to be able to provide completely unbiased and beneficial advise to real estate investors. I gain nothing from you going to a lawyer, but I would strongly advise anyone considering a contract for deed or other creative financing transaction to talk with a lawyer before your first deal (or if you have already done your first deal, before your next deal).

If you need help finding a lawyer, you can start with Spence Stover or Julie Anderson who are both attorneys and members of MAREI. Additionally, we have several lawyers listed in our business directory which is located at rdtitle.com/business-directory. Our directory also has other businesses that provide services to real estate investors, such as contractors, lenders, transactional funders, loan servicers, accountants, and more.

  • 1
    ANN CARPENTER, TAZ GEORGE, AND LISA NELSON, The American Dream or Just an Illusion? Understanding Land Contract Trends in the Midwest Pre- and Post-Crisis, August 2019, chrome-extension://efaidnbmnnnibpcajpcglclefindmkaj/https://www.jchs.harvard.edu/sites/default/files/media/imp/harvard_jchs_housing_tenure_symposium_carpenter_george_nelson.pdf.
  • 2
    HB 2322; http://www.kslegislature.org/li_2022/b2021_22/measures/hb2322/
  • 3
    18 Kan. App. 2d 672 (1993); https://law.justia.com/cases/kansas/court-of-appeals/1993/68-468.html