Contract for Deed Risks

If signing your name on the bottom of a mortgage contract puts butterflies in your stomach, buying a house using the higher-risk, contract-for-deed agreement should add a few dozen more wings to your tummy. Contract-for-deed agreements are also sometimes called "land contracts" or "installment land contracts" in the real estate business. You need to understand the risks if you're thinking about taking on this complicated real estate agreement.

Homeowners have the ability to offer the buyer a personal loan using the equity in the house. The terms of contract-for-deed agreements change with each owner-lender, but typically the homeowner demands a down payment and a contract to make the sale. The terms of the contract include monthly payments for the house, sometimes extra interest payments and also payments to cover the property taxes on the house. After a set number of payments to pay off the contract, the homeowner turns over the house to the new owner.

The risks include modification of the house payments for the new buyer. If the new buyer misses a payment or fails to pay taxes, these types of contracts frequently accelerate the required payments from the new buyer -- meaning that you must pay larger payments over a shorter period of time. Contracts sometimes include a clause to demand payment in full of the remaining contracted amount for a missed payment.

The original homeowner in a contract-for-deed still has possession of the grant deed that shows ownership and also has the ability to use the equity in the house to take out other loans. Possible liens might include construction work or mortgage seconds to take cash from the house equity. This reduces the worth of the house for the contract-for-deed new owner. Since lien holders have the first right to take the equity from the home, the contract-for-deed buyer might be left without any value in the house.

The original owner of the house holds the deed to the property. If the original house owner dies and that owner's family members take over the agreement, some state laws do not protect the new contract-for-deed buyers. The new buyers must then take legal action to enforce the original owner's contract with the buyers. The buyers also face the risk of demands for payment in full of the house contract when the original owner of the home dies.

Homeowners in some states have the ability to sell the house to buyers using the land-contract arrangement while still holding a traditional mortgage. If the original owner fails to make payments on the loan mortgage, that lender has the right to foreclose on the home to pay for the original mortgage. This leaves the new contract-for-deed buyers with a home under a foreclosure action -- with potential loss of the new buyer's investment.

Traditional mortgages allow the buyer to sell the home, pay off the loan and purchase a new home. Contract-for-deed agreements don't allow this flexibility. The contract-for-deed agreement transfers the ownership deed only after the buyer completes the payments. This reduces the ability to move after a few years.

Buyers using this agreement must find a new buyer to match the down payment and also reimburse the buyer for all the interest payments made to the original owner. Some contracts allow the seller to keep the interest payments made at the point of the contract cancellation as a penalty for not completing the sale.