Seller FinancingThe Real Estate Contract

Dated: 05/04/2017

Views: 1297

Seller Financing-The Real Estate Contract

by Rick Albright

associate broker at The M Real Estate Group

The Real Estate Contract is a document used to convey ownership of real property.  It is a form of creative financing that has risks and benefits for the seller and the buyer.  Those risks can be reduced if the seller and buyer understand how the REC works.  When I first began buying and selling property 40 years ago, I used the Real Estate contract without completely understanding what I was doing.  I was lucky, I never ended up in court and my deals were profitable.  I would not recommend doing the same thing today.  The rules have changed and the best way to work with seller financing is to use the proper documents, make sure you cover your butt with by using the proper documents, seek assistance, and be transparent about the deal you are making.

There are many reasons people use seller financing to sell their home.  It can create an installment sale, which enables the seller to defer payment of a portion of their taxes. In addition, if the buyer defaults, the seller can sue for strict foreclosure, something he or she cannot due with a mortgage.   Other benefits include faster closing time, no appraisal or survey, sell the house as is, higher interest rates for the seller.  It also expands the pool of buyers to those who may have the down payment but, can not qualify for a mortgage because they are self employed, have low credit scores, or they may not have the down payment but can afford higher payments.  Seller financing allows the seller and buyer to negotiate a deal without the restrictions that qualifying for a mortgage may impose so that both the buyer and seller can have a win-win deal. 

For the buyer, the land contract is often viewed as a way to increase equity before obtaining a regular mortgage. Often, the terms of the contract will call for 5-10 years of regular payments, concluding with a balloon payment for the balance of the mortgage. The buyers will typically plan on taking out a mortgage to make the balloon payment, since they will have had several years to improve their credit and earnings to qualify, and the loan needed for the balloon payment will be smaller than what would have been needed to buy the home up front.

A land contract or Real Estate Contract is a fairly simple concept. Basically, the seller is financing the purchase instead of going through a mortgage lender. Instead of taking out a mortgage, the buyer agrees to make regular payments directly to the seller, who still retains title to the property. Once the debt is paid off, the seller transfers title to the buyer, who then owns the property free and clear  (Kirk Haverkamp).  New regulations signed into law in 2014 have made this simple process more complex as the rules for loan originators have been extended to owners who sell their own home and provide financial assistance to the buyer..

There are risks associated with the land contract. A land contract doesn't have many of the protections that come with a mortgage. The seller retains the title until the land contract is fully paid off.  The buyer could end up defaulting and forfeiting their interest to the property if they we're to miss one payment.  If the seller is still making mortgage payments it is possible the seller's mortgage may specify that the lender can demand immediate payment in full if he or she no longer occupies the home.  In that instance, the buyer might have to pay the full balance if they wish to remain in the home.  Another possibility is that the seller might default on the mortgage and the lender forecloses and the buyer loses the property unless he or she is able to work out an arrangement with the lender. 

The laws on land contracts vary from state to state, so prospective buyers need to investigate whatever rules apply in their area. As with any major financial transaction, it's a good idea to get professional assistance before engaging in a land contract, preferably a real estate attorney who can review agreements beforehand and alert you to potential pitfalls to avoid and steps you should take.  

There are four basic ways that buyers can protect themselves when using a real estate contract to purchase property.

  1. Use a title company they can tell the buyer if the property has a clear title. They will also let the buyer know if the seller actually has the right to sell that property or if there are any liens or lawsuits that affect the property which were not disclosed.  The title company will provide the buyer with a HUD (Housing and Urban Development) closing statement which defines who pays for what and prorates property taxes.  They will also issue title insurance which helps resolve any misrepresentations and defects in the title that were undiscovered at the time the buyer purchased the property.  The title company retains attorneys who will make sure that the Real Estate Contract form is filled out properly.

  2. You are required by state law to record any document that transfers property with the county clerk. It lets the County know who the new buyer is so they can assess the property and send tax notices to the new buyer.  It will prevent the seller from selling the same property again to an unwitting buyer.  It provides the title company with a clear chain of title so they can issue title insurance.

  3. Use an escrow company which the state of New Mexico requires as mandated by case law. The New Mexico Appellate Court ruled in Montgomery vs. Cook that if the seller does not deliver a deed into escrow, the buyer does not have to make any payments and can even ask to rescind the contract and ask for all their money back.  Escrow acts as a third party who prevents the seller from improperly foreclosing on or terminating the contract.  They also provide an accurate accounting of all the buyer’s payments so the buyer can receive the deed  upon the completion of the contract. 

  4. Use a Realtor licensed by the New Mexico Real Estate Commission who is familiar with seller financing.  The Realtor will provide standard forms produced by the Realtor’s Association of New Mexico one of which is an approved seller’s disclosure form that requires the seller to disclose in writing any defects in the property.  The Realtor assist the buyer to fill out a purchase agreement and attach the proper amendment that provides the details of the contract.  He or she will also provide the necessary documents to comply with federal law based upon The Dodd-Frank Wall Street Reform and Consumer Protection Act (Act) which was signed into law on July 21, 2010. The Act amended the Truth in Lending Act (TILA) by adding provisions that define and govern loan originators. (RANM Form 2405) The RANM real estate contract is a highly evolved document designed to protect both the buyer and seller that has been jointly crafted by attorneys, escrow companies, title companies and the Realtor’s Association of New Mexico using over a half a century of NM case law and provides maximum protection for all parties involved in the transaction (Rick Thom).

By following these four simple steps, two of which are required by law, a buyer will be well protected from any unscrupulous seller when using a real estate contract to purchase property.

Thank you to Rick Thom who wrote and excellent articleWays Buyers Protect Themselves When Using Real Estate Contractsposted on thesecurityescrownes.comon July 5, 2102; Kirk Haverkamp who posted the articleBenefits and Risks of a Land Contract” on  on February 20, 2010;  Norma Giaquinto from Old Republic Title who made a presentation to The M Real Estate Group on March 5, 2017 entitled theReal Estate Contract.

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