If you don’t want a traditional mortgage, or if you can't qualify for one, contracts for deed and lease-to-own agreements give you two more options for purchasing a home. Each of these arrangements provides certain advantages or risks, but if you have trouble coming up with a hefty down payment on a home or your past credit history is less than stellar, they can open up property ownership to you. And if you have property you want to sell, offering a lease-to-own arrangement or a contract for deed could help you find buyers in a tough market.
Contract for Deed
With a contract for deed, the seller of a property and the person who wants to buy enter into a contract in which the buyer agrees to pay off the price of the property in installments. The contract may or may not require a down payment. As with a traditional mortgage, each payment includes interest. While the seller in a contract for deed holds the title in the property until it is paid off, the buyer holds what is known as an equitable title. He can live on the property and make improvements and he is responsible for paying the taxes and insurance. In many ways, a contract for deed acts like a traditional mortgage, except the buyer can’t use the equity he’s building in the house to take out a home equity loan.
Lease to Own
With a lease-to-own agreement, the seller of a property puts part or all the rent you pay toward the final purchase price of the house. The buyer usually sets the final price of the property at the time you enter into the lease-to-own agreement and grants the renter the exclusive option to buy the house for a specified time, such as a year. If the renter decides not to exercise her option to buy, the seller keeps the rent, the agreement is void and the seller can put the house back on the market. If the renter does decide to buy, the payments she’s made to that point are credited against the agreed-upon purchase price. At this point the parties involved can agree that the renter will seek a traditional mortgage, or they could enter into a contract for deed. During the term of the lease-to-own agreement, the relationship remains one of landlord and tenant. The landlord is responsible for paying property taxes and owns the property in the eyes of the law.
Since both lease-to-own agreements and contracts for deed don’t involve banks and financial institutions, they require less paperwork than a traditional mortgage. Someone with less-than-stellar credit or who doesn’t have the savings for a big down payment can enter into one of these agreements, so they’re an avenue to owning a home for people who might not be able to otherwise afford one. A lease-to-own agreement allows a landlord to maintain control of the property while the tenant is paying on it but offers the security of a potential buyer down the road.
As the buyer in a lease-to-own contract, you’re still essentially renting the property and will need permission from your landlord to make improvements on the property. As a seller in such an agreement, you’re still stuck in the landlord role, collecting rent without any interest attached, always with the potential for the tenant to back out of the sale. With a contract for deed, you’ve sold the property but still hold the title, and instead of getting your money all at once from a bank, the payments arrive each month. If the buyer defaults, you’re stuck with the legal hassle of enforcing your contract or voiding it.
The Atlanta Legal Aid Society warns that contracts for deed and lease-for-purchase agreements are rife with potential to be scams. Because they’re usually used with buyers who can’t qualify for a traditional mortgage, they can be used to take advantage of people who are desperate for a home. The seller may write the contract for deed so that if the buyer misses even one payment, the contract is void. The seller then loses all the equity he’s built to that point. With a lease-for-purchase agreement, if you can’t qualify for a mortgage at the end of the term of the agreement, you could lose all the money you’ve put into the house. The key to making these agreements work is to go into them with your eyes open to all the possibilities, to make payments on time, and to work on repairing your credit to the point where you’ll qualify for more traditional financing.
Cynthia Myers is the author of numerous novels and her nonfiction work has appeared in publications ranging from "Historic Traveler" to "Texas Highways" to "Medical Practice Management." She has a degree in economics from Sam Houston State University.