Rent-to-Own and Contract for
Deeds: Sellers Beware!
12.4.08
By: Stephen J. Nash
Nash & Lodge, PLLP
nash@nashandlodge.com
Finding a buyer who
can qualify for a mortgage to buy your home is a challenge in todays market so many sellers are considering
offering buyers seller alternative financing. While there are a number of different options that sellers can make available,
you need to make sure that you understand any financing alternative that you will offer a buyer. Each
have benefits and negatives that must be considered and applied to your situation. In addition, the exact terms of the financing
are extremely important understand. These are not “standard” documents. As the seller you need to have the financing
option that you are comfortable with drafted to meet your needs and concerns.
What types of alternative
financing is in the market place today? The following are alternative financing options that we will
look at.
“Rent With Option
to Own”, Lease/Option” “Rent to Own”
“Contract for Deed”
Rent With Option to Own
This type of financing has many names but they all have the following
in common – the buyer enters into an agreement where they initially rent a home with the the
of later buying the property. Generally, a seller will require an upfront option fee and monthly option payments over the
monthly rental payment. Often a portion of the rent will be credited towards the purchase price if the buyer actually purchases the property.
The positives of this type of financing is that it expands the number of potential
buyer that can purchase your home. Because of so many buyers losing their homes because of the financial
crisis in the United States, there are many buyers who have good incomes and would make great renters/buyers.There are risks associated with this type of deal. First, the renter may never turn into a buyer. Second, the purchase price has to be realistic.
Until the values start rising again, delaying the actual time of purchase is not going to get you a higher purchase price.
Third, you are taking the risk that the renter makes all of the rent payments and does no damage to the home.
A seller has to first look at this transaction as a rental
transaction. The landlord must make sure the renter is a good financial risk and is worth entrusting the home to. The
seller must know what the fair market rental value of the home is and require a damage deposit that makes the risk of renting
worthwhile. Landlords should remember that if the damage deposit is the “last months rent”, the landlord really
has no deposit in case of damage to the property. The bottom line is would you rent to this person on these terms if there
was not option?The
seller must then make sure that he/she is protected with respect to the option. If the seller is
going to give the buyer an option to buy the property, the seller is restricting his/her rights by tying up the property
and should not do so without be paid for taking that risk. Many sellers on options require an initial option payment (over
and above the rent damage deposit) and additional monthly option payments (over and above the monthly rent). The bottom
line is would you give this option to this buyer on these terms if they were not also renting?
As a landlord,
you are taking all the risks of any other rental situation. If they do not pay their rent or damage the property, you may
have to evict them which costs time and money. Since they have possession of the property, they can do damage to the property.
Make sure that you properly qualify any renter/buyer.
Another inherent risk in this type of transaction is whether your mortgage
allows a rent-to-own transaction. If it violates your mortgage, your lender could determine that
you are in default and start a foreclosure. You also have to remember to change your insurance to make sure you are properly
covered. Your current insurance covers you as an owner/occupier, not as a landlord.
As
a landlord, you cannot have a “simple”, generic lease. You need to make sure that your interests are fully
protected. Many times leases are taken from the internet and are not appropriate for a house lease
or were intended for a different state with different laws. Your home is too important of an asset to risk with a poor lease.
As
a seller, you need an option that integrates into the lease, protects your interest and is enforceable. In many situations, the option does not spell out all of the terms of the purchase which makes it difficult to impossible
to enforce. These are not simple transactions and need comprehensive documentation so that you are protected.
Contract
for Deeds
Contract for Deeds are also being used to provide buyers with alternative financing.
A contract for deed is a way to sell real estate over time. The seller still owns the property but
the buyer agrees to a purchase price and terms to pay that purchase price over time. If the buyer makes all of the payments,
the seller will then deed the property to the buyer who then becomes the owner of the property. The
buyer gets to occupy the home while the payments are being made (I.e., the buyer does not have to wait until the purchase
price is paid to occupy the property). In most cases, the contract has a “baloon payment” where the balance
owed becomes due.
The positives of a contract for deed is that it provides a method to purchase a house
over time when conventional financing is not available. If the buyer fails to make the required payments
or otherwise defaults the seller can cancel the contract for deed without having to go to court in as few as 60 days.
The downside of contract for deeds are that the seller is giving up
possession of the property to the buyer. Even though the seller retains the right to cancel the contract,
a malicious buyer can cause a lot of damage to property in a short period of time. The other risk the seller takes is that
the buyer will not be able to find financing to pay off the contract for deed when the balance is due. The seller must
use due diligence to make sure that the buyer is a good financial risk. The seller must also satisfy him or herself that
the buyer will not damage the property. A substantial down payment goes along way towards reducing
the sellers risk. The money paid to the seller is what the buyer is risking. Because the seller is taking a greater risk
than a landlord, the buyer should be willing to pay more than they would under a lease. The bottom line is the more money
paid by the buyer that is over an above what would be paid as a renter, the more security the seller has that the buyer will
perform under the contract.
There are standard contract for deed forms but they are generic and
do not properly protect a seller in this type of protection. Since the seller is entrusting an extremely
valuable asset to the buyer, the seller should make sure that the contract for deed is drafted to protect the sellers interests.
Conclusion
Alternative financing can provide a great way to find a potential buyer
for your home in a down market. Unfortunately, there are a number of hidden traps that can doom the
transaction for failure.
The best way to protect yourself is to hire a reputable, experienced
real estate professionals. You need a reputable, experienced real estate agent who will help you
find an appropriate buyer with a realistic purchase price so that the property will ultimately appraise high enough so the
buyer can obtain financing. You need a reputable, experienced real estate attorney who understands these transactions so
that he/she can explain the risks and benefits of the transaction and draft provisions that better
protect your interests.
All of these real estate professionals should be able to work together.
Each of them bring something needed but different to the table to best help protect your interests.
If any of these professionals refuses to work with the others, the transaction will become that much more difficult to
complete in a manner that best protects your interests.
If you would like to discuss your situation with an attorney of Nash
& Lodge, call 763.862.6100 or send us an e-mail at nash@nashandlodge.com. We offer hourly rates and flat fee options.