What are the differences from a Rent to Own and a Contract for Deed in Minnesota ? Without me getting into a full rent to own article here, as a general rule a rent to own, gives you what’s called an “option”. The option gives you the first right of refusal to buy the property.  This means the buyer can buy on a rent to own, but doesn’t have to, the seller does have to sell on a rent to own if the buyer wants to with buy and exercise the option. It’s a one way contract also known as a unilateral contract.  In addition, the rent to own usually takes far less money down than a contract for deed would, maybe a little less paperwork, and a rent to own is simply the option to try to purchase at a later date.  A contract for deed is a sale of the property, and usually requires a pretty good size down payment, and probably recommended an actual closing at a title company or attorney’s office when doing a contract for deed.  Contract for deeds are going to put tax write-offs on the buyer’s side of the equation, whereas rent to owns are going to keep the full ownership and tax related info all on the seller’s side.

How much money is needed for  a down payment on a contract for deed? There is no one answer for this question, let me explain.  The down payment needed for a contract for deed is determined by so many factors, some of those would be: How many agents are involved in the deal, what size is the house, what is the seller’s comfort level, what is the buyer’s credit like, how do the terms look, where are you finding the contract for deeds, what’s the location and condition, what are the seller’s reasons for selling.  One of the biggest misconceptions I hear about contract for deeds is that their just isn’t any c/d’s available out there, or they are too hard to find.  My response to this comment is that it’s because not enough people know what they are, so they don’t get advertised that often.  If I call sellers and present the idea to them, they are likely to be open to it, especially with a sizable down payment and especially so, in this slow housing market and economy.  I find getting the sellers for contract for deed’s one of the easier parts of the equation, it’s finding buyers with a sizable down payment that want to take it as a serious purchase, those buyers are a little harder to find, so  let’s discuss how we arrive at the down payment amount that is needed for these contract for deeds:

How many agents are involved: Most houses that buyers are looking for are listed on the MLS.  What this means is that their is a listing agent who has typed up all of the information, which does take a lot of the listing agents time. This listing agent also has this property under contract exclusively with this seller, in most all cases.  This listing agent is working for the interest of the seller to help them sell the house to a new buyer.  Almost every seller wants to sell with a new buyer that has financing, so that they can completely cash out of their existing financing.  When they completely cash out, in most cases, hundreds of thousands of dollars come from the new buyer’s lender to pay off all existing loans, seller’s, listing agents, buyer’s agents, etc.  Everyone gets paid, and everyone is happy.   When their is a house listed on the MLS, what you will need to understand as a buyer is that the listing agent often needs about 2.5% commission for him or herself, and the buyer’s agent usually likes to get 2.5-3.0% commission also for working with the buyer, writing up the paperwork, helping with the closing, searching for properties, showing houses, etc.  Buyer’s need to fully understand that this can be up to 5.5-6% in total commissions, even though the seller customarily pays for it.  This is the part that buyer’s need to understand better that they don’t yet.   As a contract for deed buyer you are asking the seller to give up a lot of tax write-offs.  In addition, the seller has to give up ownership, and let someone move into their house.  The seller is giving up a lot of their rights to let someone move in and become the new owner.  The reason you need to keep this in mind is that the seller needs to pay out nearly 6% in real estate commissions to get all agents paid for putting the transaction together and closing it.  Also the seller needs a pretty sizable down payment to make it worth their time and efforts and the risk and costs involved.  You can see why so many seller’s ask for 10-20% down payment from a buyer as a minimum.   Can a buyer get a contract for deed with $4000 down payment, in other words like only 2%?  Sure you as the buyer can, you just need to contact a seller directly and know what you are doing, and a lot of legwork and time is involved.  Don’t underestimate though how much time, and future heartache and potential problems can be avoided by having an experienced agent put together the transaction together for you.  You may put together the paperwork on your own today, but after thousands of dollars and years realize how big of a mistake you made because you didn’t hire an agent to help you.  Agents had to take years and a lot of hours of practice to learn what’s best for you with different scenarios.

What size is the house: Generally speaking the larger the house, the more of a down payment the buyer will need.  If it’s a 1100 sq ft house, that’s an older house in St. Paul, 5% down payment will probably work.  If you are looking for a $500,000 house that’s in Edina in excellent shape, those seller’s are less picky and will wait a month or two to find the right buyer in most cases. They may want 15-20% down payment.   The better the condition, better location, and less motivated the seller is, the better the chance they will demand a larger down payment.

What is the seller’s comfort level: The seller’s comfort level has a lot to do with how much of a down payment they want.  If the seller is worth $500,000 net worth, and has an extremely nice home, they probably are less comfortable with a contract for deed, and not at all desperate to let someone live there or own the house on a contract for deed for such a small amount of money.  The reason is that the seller knows the time and money it takes in the worst-case scenario to kick the contract for deed buyer out of the house, cancel the transaction, and clean up the house from the damage left behind.  A seller behind in payments or that has a house that needs repairs in a bad neighborhood is more likely to let you buy on a contract for deed from them for a low down payment, but as a buyer that may not be smart for you to buy, due to the circumstances.

How is the buyer’s credit: With some seller’s the buyer’s credit matters a lot.  As a seller myself that would consider selling a house on a contract for deed to someone, here are some concerns I personally would have with the buyer I choose:  The reason I explain this to you is for you to be very upfront as the buyer and explain it to whomever you do a transaction with.  As a seller I would be a little concerned with a buyer with bad credit, but my biggest concern is a background check for a criminal background.  I would be concerned about recent bankruptcies, pending, discharged, etc. I am also concerned with recent short sales or foreclosures on the buyer’s record.  That doesn’t mean I won’t sell to them, it’s just something I need to know up front, here is why:  Some lending guidelines these days are asking for up to 2 years before someone can get financing after a recent bankruptcy.  That would be something both the buyer and seller need to keep in mind.  At the time of this post I have information stating that FHA will allow financing to someone only 3 years after a foreclosure, whereas Fannie Mae is getting stricter with a 5-7 year wait after a foreclosure.  This is something the buyer and seller should both be well aware of going into a long term purchase contract.  Also a recent short sale of the c/d buyer’s previous house sale may need you to allow up to  2 year wait of a future finance purchase.  These are all things to plan for and discuss ahead of time with both buyer and seller.  Also if the buyer’s credit score is very bad, like in the 400′s, then it could take many years and strong financial discipline to get up to a credit score that would ever allow for financing.   I will tell you as a seller myself, that someone with bad credit, that has a large enough down payment would make me feel better about accepting them as a buyer, so as a buyer, try to have a large down payment, this is very important today.

How do the terms look: Terms are negotiable with the buyer and the seller in most cases.  What I mean by terms is the interest rate paid, which determines your monthly payment.  Also it will be decided if it will be an interest only payment, or a amortizing payment. In addition,  we need to keep in mind the balloon date and term.  The balloon date is simply the date the full amount of the loan must be paid off by.  What this means to you as the buyer is that you may make your contract for deed a standard 2 or 3 year balloon term.  This means you make your down payment at the time of the closing with the title company.  The remaining balance of the purchase price minus the down payment is due by the end term of that balloon.  That’s the deadline, you could always renegotiate with the seller if they are willing to.  2-3 years in most cases is plenty of time to get financing lined up and get your credit score fixed or much higher.  One other part of the term may be how much of a down payment you are putting down.  Their are minimal closing costs involved with a contract for deed, such as title closing fees, pro-rated taxes, city assesments, etc.  Fees are pretty negotiable, so you will want to work a win-win on these terms with the seller.   Also as a buyer you would record the contract for deed, showing you have ownership in the country records. At the time of this writing you are required to record the contract for deed within 4 months. There are reasons why people don’t want to record, but let’s discuss doing what is suppose to be done, show on record as the new owner, and later you can try to refinance the property and also create a cloud on the title, and with that cloud on title, the seller can’t easily go pull more cash out of the property or create more new liens on the property.

Where are the contract for deeds being found: Many contract for deeds can be found on the MLS (Multiple Listing Service) I personally think that contract for deeds are created and negotiated and not easily found through advertising. What I mean by that is a lot of it is behind the scenes with sellers.   Let me explain:  I know many landlord and seller’s in the real estate business.  Of them, most of the landlords are fully aware that they can rent out their property or simply sell their property to a finance buyer.  Sometimes it takes me as an agent or investor, to come to them and ask if they would be willing to sell the house on a contract for deed for the right buyer with a solid down payment. In this scenario I may have to explain to them what a contract for deed is.  In many cases this makes sense to the seller, if the seller is willing to hold the property for awhile, is current on payments, and their payments are fixed for awhile with a locked interest rate.  Finding the properties and seller’s is usually not a problem for me if the buyer is a little flexible on the kind of property, I just find these days that I need more buyers with a larger down payment to make it make sense for everyone involved in the transaction, so everyone gets paid including the buyer’s agent, listing agent, and seller.

Where are the CD’s located and what is the condition of the house: As a general rule houses available on a contract for deed for ownership and larger down payment are probably going to be in better shape and located in better suburbs and cities, or at least more to choose from. The houses are likely not going to have deferred maintenance like some rental properties do.  The more money you put down, the more of a selection you’ll have as a buyer.

What are the seller’s reasons for selling: The question of why a seller would ever sell on a contract for deed would have many answers.  Many sellers would like someone to take care of the property and take ownership of the property vs. just renting out the property. It’s less of a headache and less time involvement for a seller to just sell the property.  Also a substantial down payment to the seller will ease the seller’s fears about damage and how serious the buyer is.   Also the seller thinks the chances of the buyer following through with a purchase increases in scenarios with a substantial down payment.  The seller would want to be more hands off on the property.  The buyer is going to make the repairs and take full ownership for the property, pay property taxes, insurance, and basically everything.  The seller may just not have time for the property anymore with the managing of it.  Also some seller’s, depending on their age and financial situations may find that selling on a contract for deed is better for them in relation to their taxes then compared to getting one lump sum from a buyer with financing who cashes them out.

What are the PRO’s for a Seller on a Contract for Deed: The pro’s for the seller when selling on a contract for deed, have mostly to do with peace of mind that the new buyer will take care of the property. That the buyer will put up a big down payment instead of just a rental deposit, further protecting the seller from damage and exit costs.  The seller will lose some tax write-offs, but may find them in other ways if he/she has a lot of equity.  The seller gets someone who will likely take care of the property, probably much more likely than a straight rental for a landlord.   The seller has a much higher chance of selling the house to that C/D buyer if the buyer put down a large down payment, and the seller has more of an incentive to help the buyer out with their time and commitment in improving credit scores and doing legwork to make it a win-win.

What are the CON’s for a Seller on a Contract for Deed: The part about a contract for deed that’s not as good for a seller is that it can take 60-90 days to get the buyer out of the property if they default.  They have to go through 60 days of defaulted payments, and then cancel the contract and go through the legal steps to force out the buyer who would have defaulted on the paperwork.  This 60-90 days is much longer than about the standard 3 weeks it takes to evict a renter.  The other bad part for a seller is if they get very little money down, it isn’t enough to pay agents or for the potential damage or time it takes to get rid of the buyer.  Other disadvantages for the sellers of a contract for deed is they are giving up tax write-offs and depreciation to the new buyer, this may not be a good deal unless they are getting something from the buyer in return, like a future sale, or a large down payment, or cashflow from a high interest rate.  The seller is also giving up ownership to the new buyer, who can now take that house and make it there own.  One thing a seller will want to realize when selling on a contract for deed is they will want to pay special attention on how it will affect them with taxes, this will best be answered by their accountant.  For example when you sell for much higher, essentially a larger profit, you may have to pay taxes on the large profit, even though you haven’t yet felt the gain. There are ways around this, so please check with your accountant. Also in addition a seller is not recommended to sell a house at an extremely low interest rate, in turn for an inflated purchase price, basically playing around with the numbers. The IRS may have something to say about that (The term is imputed interest). Please check out this page here, I am not sure if it’s the correct page, either way bring this up to your accountant, if needed.  http://www.irs.ustreas.gov/taxpros/lists/0,,id=98042,00.html. This pages is about Applicable Federal Rates (or AFRs).

What are the PRO’s for a Buyer on a Contract for Deed: The pro’s for a buyer on a contract for deed, is that they can get home ownership without using a bank, for today.  The buyer could get some great balloon terms, and a decent interest rate they couldn’t get today at a bank with their current credit.  The buyer can later refinance the property after showing on title for typically 12+ months.  Refinancing the property usually offers more competitive terms and far more options and lending programs than a straight purchase, as you will go off an “appraised value” on a refinance, where that would not be so with a new purchase.   The lender recognizes the previous ownership  and sees the buyer on title and would allow for a refinance.  The buyer gets interest write-offs and depreciation write-offs in some cases. You will want to seek the advice of an accountant on this, as it will make a difference whether you are living in the house or buying the contract for deeds as investment properties.  The balloon term allows for the buyer to give themselves often 2-3 years to get their credit score up and improved, so that they can later finance the property.  The buyer is generally protected with a cloud on title once the property is recorded with the county.

What are the CON’s for a Buyer on a Contract for Deed: The disadvantages for a buyer on a contract for deed is if the buyer put down a large down payment, but wasn’t going to follow through with the purchase.  If the buyer were to enter into a contract for deed with a previous foreclosure or bankruptcy and didn’t allow ample time to get finance for the contract for deed, this may not be good for the buyer. If the buyer didn’t put in effort to increase their credit score, that could end up not working out for the buyer.   The buyer has fewer options on a contract for deed then they do with financing just simply because many seller’s don’t know what a contract for deed is or don’t want to give up the rights to their house.  If the buyer wanted to finance within a few months but first bought on a contract for deed, the buyer would likely have to wait up to 12 months to refinance the property, due to title seasoning rules with the current lenders and financial markets.   Buyers who put down a large down payment should probably be certain they want that home and want to later finance it before putting out the time and money.

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