Contract For Deed vs. Lease / Option

• Here is an excellent article from my attorney Harry Borders and attorney Jenny Fields with Borders and Borders Attorneys
  
  
  
  I. LEASE OPTION VS. CONTRACT FOR DEED
  
  
  
  1. Contract for Deed: With a contract for deed, the title transfers to the purchaser upon the execution of the contract for deed. The seller is in effect acting as a mortgage company. A contract for deed is typically used when the seller has an existing non-assumable mortgage on their property.
  
  
  
  A. Advantages of Contract for Deed for Buyer:
  
  i. Appreciation of the property
  
  ii. Tax benefits of home ownership
  
  iii. Lower closing costs
  
  iv. Can purchase a house even with bad credit
  
  
  
  B. Advantages of Contract for Deed for Seller:
  
  i. Seller now has someone else responsible for the house payments
  
  ii. Reduced liability since the seller no longer owns the house
  
  iii. Quick closing
  
  iv. Stops the financial bleeding of owning potentially two houses.
  
  v. Buyers often will pay more money if C for D.
  
  
  
  C. Disadvantages of Contract for Deed for Buyer:
  
  i. Interest rate is typically higher than conventional financing
  
  ii. If contract for deed is not recorded, any liens against seller would affect the property (therefore, its best from buyer’s perspective to record the contract for deed).
  
  iii. Risk of “due on sale” clause. Most mortgages have a due on sale clause that says if the seller sells the property, they must pay the loan off. With a contract for deed, we are selling the house and NOT paying the loan off. If the lender learns of the sale, they could force the buyer to either refinance the debt (which is probably going to be difficult, or the buyer would have simply gotten their own financing in the first place), or sell the house.
  
  iv. Risk of seller not making their payment to their lender thus resulting in the property being foreclosed upon.
  
  D. Disadvantages of Contract for Deed for Seller:
  
  i. Seller does not get a release of liability under their original note. Therefore, if buyer stops making their payments, the seller still must make their payments to their lender or they will have a foreclosure on their record. Therefore, if possible, seller should try to get a large downpayment from the buyer.
  
  ii. Since the seller’s loan has not been paid off, this debt still shows up on the seller’s credit report which could cause them problems when they are trying to get a new loan.
  
  iii. If buyer stops making payments, the only way to get the buyer out of the property is to file for a foreclosure. This will take 8-12 months to complete.
  
  iv. Risk of buyer damaging the house if seller gets house back later.
  
  E. Other Issues with Contract for Deeds:
  
  i. Have buyer go to L.O. to clean credit and tell how long until they can obtain a loan.
  
  ii. Length of time for C for D. Not too long.
  
  iii. If seller has no mortgage, straight owner financing, not C for D.
  
  iv. Use GLAR contract and modify it for C for D contract.
  
  v. Escrow for taxes and insurance?
  
  vi. Insurance options: 1) double insure; 2) add buyer as additional insured.
  
  vii. Run title exam and have actual closing.
  
  viii. Seller to have credit check on buyer.
  
  ix. Seller to get BIG downpayment.
  
  x. Agent MUST have parties sign Agency Disclosure forms.
  
  xi. Who pays for repairs? Typically buyer, but spell it out.
  
  xii. If buyer wants to sell during term of C for D, both buyer and seller must sign the listing agreement.
  
  xiii. Does agent have liability if loan called due? NO, if agent fully discloses the risks to the buyer and seller. But, isn’t this “wrong” to do? No, it’s a calculated risk.
  
  
  
  2. Lease Option: With a lease option, the seller does not transfer legal title to the property to the buyer. Rather, the buyer has a lease on the property with an option of purchasing the property at a set price at a later date.
  
  A. Advantages of Lease Option for Buyer:
  
  i. Buyer gets a house that they could not otherwise afford.
  
  ii. Buyer has set the price at today’s value therefore, should benefit from the property appreciating.
  
  iii. Lower fees than a traditional closing.
  
  iv. If buyer has bad credit, they may still be able to get into a home.
  
  B. Advantages of Lease Option for Seller:
  
  i. Seller has income to help pay their mortgage payments on the house.
  
  ii. Some of the liability now goes to the buyer.
  
  iii. Seller retains the tax benefits of home ownership.
  
  iv. House is now occupied and therefore, the insurance rates are lower.
  
  v. Typically, the buyer is now responsible for making the repairs to the house (this is typically not the case with a simple lease with no option to purchase).
  
  vi. Stops the bleeding for the seller owning two houses.
  
  C. Disadvantages of Lease Option for Buyer:
  
  i. No tax benefits for the buyer.
  
  ii. Easier for the seller to get the buyer out of the house.
  
  
  
  D. Disadvantages of Lease Option for Seller:
  
  i. Seller is still on the loan and therefore still responsible for payments if the buyer fails to make payments.
  
  ii. Seller still has some liability in the event of an accident at the property.
  
  iii. Seller may have to sell the property again if buyer does not exercise their option to purchase.
  
  iv. If seller gets the house back, buyer may have damaged the house.
  
  E. Other Issues with Lease Option:
  
  i. Lease AND Option, NOT a lease option form. And, don’t make it look too much like a contract for deed. Otherwise, seller must foreclose on buyer, not simply evict.
  
  ii. Have buyer go to L.O. to clean credit and tell how long until they can obtain a loan.
  
  iii. Length of time for lease and option. Not too long.
  
  iv. Use GLAR lease and separate option contract.
  
  v. Who pays taxes and insurance?
  
  vi. Run title exam.
  
  vii. Seller to have credit check on buyer.
  
  viii. Seller to get BIG downpayment.
  
  ix. Agent MUST have parties sign Agency Disclosure forms.
  
  x. Who pays for repairs? Typically buyer, but spell it out.
  
  xi. If buyer wants to sell during term of C for D, both buyer and seller must sign the listing agreement.
  
  xii. Record a copy of the option to keep seller from selling to someone else.
  
  
  
  3. Commission Issues: Obviously, with a lease option or a contract for deed, the Realtors would like to get 100% of their commission at the time of the execution of the lease option or the contract for deed. However, since the seller is not typically getting all of their equity at the time of execution and since the seller still has liability under their original promissory note on the property, it is not unusual for a seller to prefer to pay the commission at the time their promissory note has been paid in full, not upon the execution of the lease option or contract for deed. In this event, it is critical that you discuss the situation with your broker. Whatever decision you and your broker come to about the payment of the commission, you must put in writing the terms of the payment of the commission and have the seller sign agreeing to pay according to these terms. One agent acts as property manager during the term of the lease option or contract for deed and collects 10% of payment and applies to his commission at the time he is paid in full.
• article prepared and presented by Harry Borders and Jennifer Fields.
• Borders and Borders Attorneys
• 920 Dupont Road, Louisville, KY 40207
• (502) 894-9200