Key Takeaways
- A contract for deed is an owner-financed real estate transaction.
- Contracts for deed are often used to help people who cannot qualify for a mortgage to buy a home.
- If you sell your home using a contract for deed, you will receive regular payments from the people who purchased your property. You will also retain ownership of your property until the full principle is paid.
- You can sell your contract for deed to a third party if your contract allows it, freeing up the money you have used to finance the original agreement.
What Is a Contract for Deed?
Someone who buys property under a contract for deed does not borrow money from a bank to make their purchase. Instead, the buyer pays for the property with regular installment payments to the current owner. Installments continue until the total amount the buyer has paid is equal to the full agreed-upon purchase price.
Buyers who cannot qualify for a traditional mortgage typically purchase property using a contract for deed arrangement. Additionally, some individuals buy property from friends or family members this way to avoid getting any third parties involved.
How Contracts for Deed Work
Contract for deed arrangements typically follow these steps:
- The buyer and seller negotiate and agree on a price for the property. That price becomes the principle of the contract for deed.
- The two parties work out details of the contract, such as how long the loan’s amortization period will be and whether there will be a balloon payment at the end of the contract.
- The buyer makes a down payment on the property, known as earnest money, to show that they are serious about making the purchase. The down payment is put toward the principle of the contract for deed, and the buyer then takes possession of the home.
- The buyer makes regular payments, which usually include interest toward the principle.
- Once the amortization period ends, the buyer pays any remaining balance. Once the buyer pays the loan in full, the deed to the property is transferred to the buyer, who becomes the property’s legal owner.
Make sure your contract for deed arrangement is legally binding before you accept any payments or before you allow the buyer to move into your property. Without a legally binding agreement in place, you might not have many options to deal with problems, such as a buyer defaulting on payments.
Contracts for deed are more flexible than traditional mortgages. Besides allowing buyers to skip a credit check, the agreement eliminates many closing costs involved in a typical real estate deal. It is also easier to cancel a contract for deed because of non-payment than it is to foreclose on a mortgage.
Contracts for deed are not rent-to-own arrangements. In a rent-to-own arrangement, the tenant has an option to purchase the property after paying rent toward it. In contrast, the buyer in a contract for deed arrangement must purchase the property unless there is mutual consent from the seller.
Sellers also maintain more control over the property in rent-to-own arrangements. They are responsible for paying for property taxes and repairs and can veto any proposed major alterations to the home or landscape.
The IRS normally classifies a contract for deed as an installment sale when the buyer makes payments over an extended period to purchase property from a seller. A gain from the sale can either be reported partially when each payment is received by using the installment method or in full in the year of sale.
Ebony J. Howard, CPAAccounting, Personal Finance and Income Tax ConsultantEbony J. Howard is a certified public accountant and freelance consultant based in Atlanta, Georgia. Ebony has a deep knowledge of the financial landscape and a background in accounting, personal finance and income tax planning and preparation.
When Does It Make Sense To Sell Your Contract for Deed?
There are situations when you may want to sell your contract for deed before the buyer finishes paying the loan. For example, you might:
- Need immediate cash
- Not want the responsibility of collecting payments
- Want to get your mortgage off your credit report
- Want the property off your list of assets for tax reasons
If you sell your contract to a third party, whoever buys it will own both the property and the agreement. That new owner would collect payments from the original buyers.
There are benefits to selling a contract for deed. You can use proceeds from the sale to pay off debt, including any remaining balance on your mortgage note for the property. You could also invest the money you receive by buying more real estate properties.
But selling a contract for deed also comes with risks. Owner financing is less common than mortgage financing, so it might take some more time to find a buyer who is comfortable stepping into this arrangement. You might also have to sell your contract for deed for less than its full value. Discounting the sale price may be the only way to get a potential buyer to agree to the purchase.
How To Sell Your Contract for Deed
- Determine the value of your contract for deed.
- To do this, subtract the amount of money your buyer has already paid toward the principle from the total value of the contract.
- Decide on the sale price.
- You may not be able to sell your contract for deed for its full value. Research local market conditions to determine what price you will accept based on current conditions. Consider speaking to a real estate agent for information about the market.
- Look for a buyer.
- Not all real estate investors are open to purchasing a contract for deed. Look for buyers who regularly purchase owner-financed real estate and approach them with your offer. You can find these buyers online, through a real estate agent or by posting ads in local newspapers.
- Transfer ownership.
- Once you have secured a buyer, you can accept payment and transfer ownership of the property and the contract for deed to them. It is best to use a lawyer who specializes in real estate transactions.
There are four major steps involved in selling a contract for deed.
While you have many legal requirements to meet to cancel a contract for deed, you can sell your interest at any time, provided your contract permits it. The third-party buyer will then assume ownership of the contract and the property until the original property buyers have paid off the contract in full.
