Buying A Minneapolis Duplex On A Contract For Deed: The Good, Bad and The Ugly

Every now and then, duplex buyers tell me they want to purchase a property with a contract for deed.

A contract for deed is an alternative means of financing in which the seller acts as the lender for the duplex purchase rather than a bank. The buyer makes monthly payments to the seller and takes immediate possession of the property.

Terms of the loan are negotiable. The seller and buyer agree on an amortization schedule and interest rate.

One common misunderstanding is that a seller must hold a contract for deed for 30 years. Nothing could be further from the truth. Most contracts for deed are for five years or less, with a balloon payment. In other words, when the balloon payment is due, the buyer will need to refinance.

There are advantages and disadvantages to a contract for deed for both a buyer and a seller. In this post, let’s look at it from the buyer’s point of view.

Pros

• Low down payment. Some sellers require little to no money down. (In my career, however, I have found this to be the exception.)
• Homesteading. If a buyer intends to owner occupy a duplex, he or she can qualify for reduced property tax and other property tax benefits.
• Mortgage interest deduction. As the owner, a buyer can qualify for the mortgage interest and real estate tax deductions of their income taxes.
• Easier to qualify. A seller may decide to give a buyer with a less than perfect credit score a chance to buy, or not care about the buyer having a slightly higher debt to income ratio.
• May not appear on your credit report. Unless the seller reports the terms of your contract and repayment history to the credit bureaus, which may help you qualify for a traditional mortgage on other properties.
• May appear on your credit report. If you have credit issues and the seller does report payment history to the credit bureaus, it may help improve credit scores.
• Lower transaction costs. Seller financing does not have loan origination fees or loan application fees.  While it is a very good idea to use a title company to close the transaction, some of their costs may be reduced also.

Cons

• Higher down payment. Sellers typically want a down payment above and beyond their costs of selling. Agents commissions and title fees can be as high as 7-10 percent. As a seller may want at least a 10 percent down payment. Other sellers will only carry a contract for deed if the risk is low. To them, this may mean a 40 or even 50 percent down payment.e
• Faster foreclosure. If the buyer misses two payments or defaults for other reasons, the seller doesn’t need to go to court. He or she simply cancels the contract and takes possession of the property.
• Balloon payments. When it’s time to refinance, interest rates for traditional mortgages may be higher, or the buyer’s credit score may prevent him or her from qualifying for a loan. If the buyer is unable to refinance, the seller may opt to cancel the contract with a 60-day notice, and keep any down payment, equity, or principal that has been paid off.
• Repair and maintenance.  While negotiable, the seller may require the buyer to be responsible for keeping the property in good repair.
• Seller retains the title. In other words, the seller can put a mortgage or a lien on the property unless you recorded the contract with the county.
• Unfavorable terms. Loans through banks are regulated to protect consumers. Sellers are not required to have the same standards and may offer terms that favor them.
• Seller may sell the contract. Sometimes sellers have a financial need that causes them to want out of the contract for deed before it balloons. In this case, they may choose to sell the loan to another investor who may be less forgiving. The buyer, on the other hand, most likely will not have the option to sell his own interest in the property.
• Property taxes and insurance are not escrowed. Most buyers using traditional financing choose to have a portion of their monthly mortgage payments escrowed to pay property taxes and insurance.

A contract for deed can be a wonderful way to acquire property if you can find a seller willing to carry the loan. There are advantages to the seller as well, and I will cover them in my next blog.