One of the most common and oldest methods of acquiring real estate is the  "Installment Contract". This is any arrangement whereby the seller transfers an equitable interest of ownership to a property under a contract that provides for the transfer of the deed upon the buyer fulfilling the terms of the agreement. Thus, they are called a "Contract-For-Deed" or "Land Contract".  These contracts are very popular and effective in accomplishing a purchase transaction in an affordable manner, they are also misused and subject of questionable practices, scams and  fraud.

A property owner may have underlying financing, a mortgage on the property to be sold and the seller may provide an installment contract that "wraps" the seller's equity together with the balance owing under the existing loan. Most mortgages have a "due-on-sale" clause that requires the loan to be paid in full in the event the property is sold or an equitable interest is transferred. With some lenders, this can present a problem for selling the property under an installment method. However, many assume that the purpose of this clause is to prevent sales by installment contract, including bankers and attorneys.

This was not the purpose or intent of the this contractual requirement. A due on sale clause was to prevent a new buyer from assuming lower than market rate financing when acquiring real estate held as collateral. When interest rates are higher, the assumption of the lower rate by an installment arrangement keeps the lender locked in at a lower rate when it could be paid off and allow the lender to make new financing available at market rates. During the 80s when interest rates were 18% older loans could be assumed as low as 5%, perhaps less. The spread between the rates represented a lost opportunity cost that was unacceptable.

When current interest rates are the same or lower than the mortgage rate, banks have ignored enforcing this issue and thus has set precedence for the enforcement of this clause in most states. An installment contract does not release the seller from the obligations under the mortgage, it only allows another person to make payments to the seller and the seller is still required to pay as agreed. All kinds of arrangements can be made with the holder of the mortgage to "allow" an installment contract. Full disclosure and notice of an installment contract should always be given to the holder of any underlying financing in an installment contract.

Some mortgages are assumable, meaning that the lender will allow another party to step into the shoes of their original borrower. Some release the original borrower from the obligation if the new borrower qualifies for the loan. Some, like VA loans, may be assumed without qualification, but keep the original borrower liable for payments and in the case of VA benefits, reduces the original borrowers ability to acquire another VA loan. These are important aspects of underlying financing that sellers must be made aware of when wrapping the sale.

These contracts allow the buyer to assume ownership interests and acquire equity. The buyer is usually required to keep the property insured, pay taxes, maintain the property and may deduct interest paid for income tax purposes. In many states, the buyer may list the property for sale with a real estate office with a notation in the listing that the seller listed under an installment contract. Remember, the seller in this circumstance does not have title to the property until the terms of the agreement have been met and the deed delivered. These exceptions are allowed based on the accepted and customary practice in a local area due to the popularity and long history of recorded installment contracts. 

The practice of entering into an installment contract that is not to be recorded is a recipe for disaster. Recording a contract gives public notice of the equitable exchange. This is required in order to protect both parties. Life changing events such as death, divorce, bankruptcy and law suits should always be addressed in a well drafted installment contract. In the event either party to the contract fails in their obligations, a method of securing the collateral and redemption should be stated. Generally, when an installment contract is made, the seller will execute a warranty deed and the buyer makes a quit-claim deed. As these deed have already been discussed, they should be held in "escrow" with a third party such as a closing/title company, attorney or other party with an "Escrow Agreement or Instructions" agreed to by all parties. Many times these deeds are held by the seller and present problems to enforce in the event of disagreements.

With the seller holding both deeds, and the contract not being recorded, the seller perceives having total control and if the seller acts improperly the only remedy may be a court action. In some areas, courts will not enforce agreements involving real estate unless they are recorded. The buyer stands to lose all the equity established without due process. In some areas such agreements may be enforced and in some places, the seller may be required to follow judicial foreclosure requirements to secure the property in the event of default.

While there are many pitfalls to installment contracts the most common is the lack of servicing. Servicing refers to the collection, accounting and administration of the contract. When a seller services their own contract they are in a position to manipulate payments to prevent the buyer from performing under the deal. 

In order for a buyer under an installment contract to obtain future financing, they must show a payment history to the new lender. A bank will generally require proof of payment. Payment is considered to be made upon the cancellation of a check or draft, not the date it is mailed for payment. If the seller forgets or intentionally delays cashing and clearing the check, the buyer has in effect made a late payment. Many sellers have delayed cashing checks in the last few months of the contract term to set up the buyer for failure or foreclosure in order to retain the property and sell again under similar terms. This scam is "churning" the property. It is very difficult for a buyer to defend against scam as it generally requires a civil suit and perhaps thousands of dollars in legal fees. Those who fall prey to this usually walk away, after all, if they can't afford to buy it, they can't afford to fight it.

Another servicing aspect that is problematic is the seller failing to pay the underlying mortgage. The buyer may make payments as required but if the seller fails to pay the underlying mortgage the buyer is faced with foreclosure. Let's say that the contract was done with the consent of the lender and the seller is late with a payment. The lender can not contact the buyer since they are not a party to the underlying mortgage unless otherwise agreed to in writing for the bank to do so. The bank may or may not discuss the matter with the buyer. If the seller falls months behind and notice of foreclosure begins, the buyer will be contacted concerning the foreclosure proceeding. Now the buyer is faced with having to pay several months of payments in order to save the property from foreclosure or they could be required to pay the amount due in full.

Some installment contracts that are kept under wraps provide for the seller to pay the taxes from payments received. Failure of the seller to do so will result in a tax lien and perhaps a tax sale.

In short, a buyer in an installment contract should be doing their due diligence and underwriting the seller as much as a seller should investigate a buyer!  

Either party may fail to conduct other aspects of their business responsibly that cause problems in an installment contract. Poorly written installment contracts are the norm. One might say that my attorney drafted my agreement, but really, if problems arise what is your recourse, to go back to your attorney for them to defend or represent you to seek a cure? It is much easier to address potential problems at the time of contracting rather than trying to cure a problem after it becomes an issue.

We will examine installment contracts further, looking closely at the seller's side and what can be done to prevent scams. We will also look into making deals that can actually close as intended.

Bill Gulley

American Realty Institute LLC