What is a Real Estate Contract?

Sellers providing owner financing might elect to use a Real Estate Contract, Contract for Deed, or Land Contract to document the transaction rather than a Note and Mortgage or Note and Deed of Trust. There are both advantages and disadvantages to carefully consider when choosing a Contract.

The big difference with a Real Estate Contract is that the buyer will not receive the Deed to the property until the full amount the seller financed is paid in full. The seller remains the title holder while the buyer is making payments. A contract is like a layaway program for the Deed.

This differs from a Deed of Trust or Mortgage where the seller provides a Deed to the buyer at closing, transferring title to the buyer. The buyer simultaneously gives back a Purchase Money Mortgage (or Deed of Trust in some states) to the seller for the portion financed. When the amount financed is paid in full the Lien is simply satisfied.

When the seller holds fee simple title using a Real Estate Contract the buyer is holding equitable title. Since the buyer does not hold title through a Deed it is almost impossible for the buyer to obtain any type of secondary financing unless the Contract is paid off.

The buyer also risks the seller encumbering or clouding title before the Contract is paid and the Deed released. For this reason, it is often advisable to have the Fulfillment Warranty Deed held in trust by a third party escrow servicing agent.

If the buyer quits paying and the seller needs to take back the property, a Real Estate Contract often has the advantage of being faster and less expensive than a drawn out foreclosure process on a Mortgage or Deed of Trust.

The accepted use of a Real Estate Contract varies by state. They are fairly common in Western states like Washington, Oregon, Idaho, and New Mexico along with some Mid-Western states such as Michigan. However a few states, like Texas, have passed regulation prohibiting these types of Contracts.

A Real Estate Contract can be unrecorded or recorded at the county level depending on local practices. A seller can sell contract payments for cash now. However, some investors may require conversion to a note and mortgage or a note and deed of trust.

A knowledgeable title company or real estate attorney can assist in selecting the best method of documenting the seller financed transaction.

Comments

William Smith says

March 3, 2010 at 2:21 pm

What information do I need to sent along with form 5405 for a contract for title as there is no HUD-1

- TracyZ says
  
  March 18, 2010 at 9:41 am
  
  Hello William,
  
  Here is an excerpt from the IRS website for the documentation needed to claim the First Time Home Buyer Credit using Form 5405:
  
  Q. What do I have to attach to my 2009 or 2010 return to prove that I bought a new home in order to claim the credit?
  
  A. If you claim the credit on a 2009 (or later) return, you must attach a copy of your settlement statement. For most homebuyers, this will be a properly executed Form HUD-1, Settlement Statement (U.S. Department of Housing and Urban Development) that includes:
  
  * Names and signatures (if available) of all parties involved,
  * Property address,
  * Purchase price, and
  * Date of purchase.
  
  If you purchased a mobile home and do not have a settlement statement, you should attach a copy of your executed retail sales contract showing all parties’ names and signatures, the property address, the purchase price and the date of purchase.
  
  If you are claiming the credit for a newly constructed home and you do not have an executed settlement statement, you should attach a copy of your certificate of occupancy showing the name of the taxpayer, the property address, and the date of the certificate.
  
  Source: IRS Website at: http://www.irs.gov/newsroom/article/0,,id=218698,00.html
  
  Thanks for your comments and questions.
  
  Tracy Z