Is Rise in Seller Financing Trapping Buyers?

Real estate professionals are treading carefully amidst a revival in contract-for-deed sales.

A couple with three children came to Paul Sigurdson in 2014, looking to buy a home that would support their growing family. The hitch was that they’d gone through a foreclosure three years earlier and couldn’t qualify for a mortgage. Their dream of home owner-ship might have ended there, but Sigurdson, CRB, CRS, a sales associate with Engel & Völkers in Minneapolis, guided his clients toward a workaround. He helped them purchase a home with a contract for deed, a seller- financing option that’s been gaining popularity with credit-challenged buyers.

In this kind of arrangement, buyers pay the sellers high-interest installments toward the purchase price of the home. For buyers who don’t have the representation of a knowledgeable agent, it can be a risky proposition. Buyers need guidance in understanding that, under a contract for deed, they don’t accrue equity or obtain the property deed until they’ve paid off the loan. Meanwhile, sellers have the authority to evict buyers, typically in 30 to 60 days, if they miss even a single payment.

Contract-for-deed financing has been around since the 1960s and gained traction in the 1980s when sky-high interest rates were a barrier to home ownership. Some investors who bought foreclosures in bulk during the housing crisis are using contracts for deed to sell off inventory now that prices have widely rebounded.

Critics say the terms are often written to exploit naive buyers. In recent months, companies such as Harbour Portfolio Advisors in Dallas have come under fire for allegedly selling properties in poor condition to buyers who couldn’t afford the repair costs on top of installment payments—which carried an interest rate as high as 10 percent—and evicting the buyers soon after they defaulted. Buyers in several states, including Ohio and Michigan, have filed lawsuits against Harbour, and such cases have prompted the Consumer Financial Protection Bureau to begin investigating the practice.

Lawyers for Harbour declined REALTOR® Magazine’s request for comment, but Harbour attorney Jacqueline Mallett told The New York Times in February: “Harbour’s business model is to purchase unproductive residential properties and sell them to other people who will make them productive again.”

An Ethical Bridge

Not all transactions involving contracts for deed are as fraught for buyers. Sigurdson took his clients to a local nonprofit program called Bridge to Success, which offers greater protections to buyers while helping them repair their finances, he says. In addition to helping buyers make a contract-for-deed purchase, the program offers credit counseling to help them refinance into a traditional mortgage, usually within a few years. Bridge to Success also works out modified payment plans with buyers who fall behind on payments.

Since 2008, Bridge to Success has bought 177 properties in and around the Twin Cities and sold them to low-income buyers under contracts for deed at 7.5 percent interest, says Pete Flom, vice president of ShopHome Mortgage, the program’s financing arm.

In Minneapolis, a hotbed for investors during the downturn, contracts for deed peaked at 1.4 percent of all transactions in 2011, according to the Minneapolis Area Association of REALTORS®. Nene Matey-Keke, CIPS, broker-owner of RNR Realty International in St. Louis Park, Minn., still works with about six buyers annually on contracts for deed, always referring them to programs run by nonprofits or public agencies. “When you have a private seller, the scrutiny of the deal lessens,” he says. “Sellers can charge any interest rate they want, and they know they can evict someone whenever they want. Organizations, on the other hand, don’t want the reputation that they’re putting people out of their homes.”

MAAR began to pay attention to the issue after some investors were found to be using contracts for deed to skirt regulations affecting their rental properties, says Julia Parenteau, MAAR vice president of public affairs.

Not all private sellers or investors are out to exploit buyers, Parenteau says. Sellers may just need guidance on how to make the transaction work. “Maybe both the seller and the buyer aren’t quite clear on what they’re agreeing to,” she says. “It’s not that contracts for deed are inherently troublesome; it’s that people don’t always use them appropriately.”

Whether it’s with a private seller or a community agency, “it’s buyer beware,” says Mike Spicer, a sales associate at RE/MAX Metro in Brooklyn Park, Minn. He counsels buyers who are rebuilding their credit to wait until they qualify for traditional financing. If they don’t want to wait, “I tell them, ‘Hey, the seller has the right to take the house if you don’t make the payment,’ ” he says. “I try to prepare them for the worst and not set them up for a difficult future.”