Duplex Chick

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What do you get when you have tightened lending practices, then add a slow duplex market for traditional sellers?

The re-emergence of the Contract For Deed.

A Contract For Deed, which is also known as land contract, is a transaction where the seller acts as the bank. In exchange, the buyer agrees to pay for the property in monthly installments, while the seller retains legal title to the property until the contract is paid in full.

(For the record, most sellers don’t want to carry a contract for deed for 30 years, so these transactions usually involve a “balloon payment” after a few years where the buyer obtains more traditional financing for the property, thereby letting the seller off the hook.)

Frustrated duplex sellers who simply want out of their property may discover offering this type of financing allows them to sell a property because it makes it a possibility for a broader pool of buyers.

Buyers who may or may not have credit problems.

While it’s always a good idea to ask to see a prospective buyer’s credit report before agreeing to seller finance the property, what about the buyers who develop financial difficulties after they’ve bought the duplex?

The good news is Contracts For Deed are not foreclosed on, meaning the wait to get delinquent duplex owners isn’t nearly as long as it is for banks.  When a buyer falls behind on payment by just 60 days, the seller can file what’s known as a Notice of Cancellation of Contract for Deed with the county and serve notice to the buyer.

From that date, the buyer has just 60 days to cure or reinstate the contract. This usually involves catching up on payments and reimbursing the seller for attorney fees. If the buyer fails to do so, ownership of the property returns to the seller.

The seller who repossesses the property does not have to return any funds to the buyer; even if default occurred after years of payments.

And there is nothing stopping the seller from marketing the property all over again.

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With today’s tightened lending standards, many investors are having a difficult time finding financing. As a result, the contract for deed has once again emerged as a viable option.

I have had two buyers ask me this week alone to find them property where the seller is willing to do the financing.

Believe it or not,  there are properties on the MLS right now where this is an option. Many sellers, for whatever reason, simply need to no longer have the managerial responsibilities of a property.

Of course, the seller also wants to make money on his duplex.

While most forms of seller financing carry a higher than market interest rate, they often also require less of a down payment. At the moment, most banks are requiring a down payment of 25 percent on a non owner-occupied investment property. Private sellers willing to carry financing will often ask for less.

How much less?

Let’s look at it from the seller’s perspective.

If his duplex is actively on the MLS, he has signed a contract with a real estate broker. In the event the property sells as a result of his Realtor’s efforts, he is legally bound to pay a commission based on a percentage of the sales price.

So, if he’s bound to pay six or seven percent in commission on say a $200,000 property, that’s $12,000-$14,000.

In that case, is he going to be ok with a buyer putting $5000 down?

Probably not. If he did, he would have to go into his own pocket to pay not only the rest of the commission, but closing fees as well.

What’s the likelihood of finding a seller willing to do this?

You tell me.

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With the tightening credit standards and increased down payment requirements in today’s mortgage industry, many sellers have become willing to provide financing for prospective buyers via a contract for deed.

In a contract for deed, which is also known as a “land contract”, the seller acts as the bank for the buyer.

All the terms of the “loan”, including interest rate, monthly payments, amortization schedule, length and down payment requirements are negotiable, just as all of the terms of the purchase of the duplex itself are.

While a contract for deed certainly avails a seller of more prospective buyers, it’s crucial that prior to offering it, he know whether or not his mortgage has what’s known as a “due-on-sale clause”, which may also be called an acceleration clause.

When contained in a promissory note, this clause stipulates that the original lender, or bank, may require the entire balance of a loan be paid in full upon the sale or transfer of any interest in the property used to secure the note. (Please know there are some exceptions between spouses, with estates, etc.)

These clauses came into existance in the 1970’s when double-digit interest rates made new loans unattractive. Buyers found if  they assumed a seller’s existing loan, they could usually obtain financing at a greatly reduced interest rate.  To stop this practice (and offer loans at higher interest rates), banks began using the due-on-sale clause.

The truth is, most of today’s mortgages have this language. In fact, in a Fannie Mae or Freddie Mac single family mortgage, for example, it’s usually found in paragraph 17, where it’s called the “Transfer of the Property or a Beneficial Interest in Borrower”.

Uh-oh, right?

Not necessarily.

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With each day’s basket full of negative, I’m increasingly convinced the banking industry doesn’t want any of us to buy property ever again. OK, so maybe it’s not quite that dramatic, but…

First it was the end of stated income programs. 

Then it was word that as of August 8, Freddie Mac will restrict lending for investors who own more than four properties.

And there’s the looming threat of the end of gift programs for seller down payments like Ameridream, Nehemiah and Genesis.

Regardless of market conditions, people will always need to buy and sell property. There are countless circumstances other than short sales or foreclosures that necessitate a sale. Perhaps a seller faces a job transfer, an addition to the family, a divorce, or has simply happened upon a better investment opportunity.

So how are those with less than perfect credit, who own five or more properties or work for themselves going to finance real estate?

My guess is we’ll see the re-emergence of the contract for deed, which is also known as a land contract.

With the impossibly low interest rates and readily available loans of recent years, this way of financing fell out of style. (Except in the case of farm land which is often difficult to obtain conventional financing for.) However, it was not an uncommon way to finance property in the late 1970’s, when interest rates hovered in the high teens and low 20s.

Quite simply, when a property is purchased on a contract for deed, the seller becomes the bank.

How does this benefit the seller?

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