The recession of 2008 left many potential sellers and buyers of real estate without access to credit and financing. When faced with no access to traditional lender financing, like a bank or mortgage company, buyers and sellers came up with creative alternatives. While the major credit crunch appears to be behind us, buyers and sellers should not forget the creative financing lessons learned in the recession. Here are three methods buyers and sellers can still use to avoid traditional lender-financing (and some of the costs associated with it!):
1. Contract for Deed
Under this method the buyer and seller enter into a contract where the seller agrees to sell the property for a set price and the buyer agrees to make payments (weekly, monthly, annually—whatever is acceptable to both sides) until the full purchase price is paid, then the seller signs a deed conveying title to the buyer. This has the advantage of avoiding financing costs, and it allows someone who has not built up their credit or has hit a difficult patch to buy a home that otherwise could not secure traditional financing.
Buyers and Sellers beware though: this method is not without potential pitfalls. If either party dies before the total purchase price is paid that can create problems and you may find yourself dealing with a spouse or the heirs. Also, if the buyer defaults, the seller can move to evict the buyer immediately. The seller is not required to go through a foreclosure process and a buyer can lose all the equity built up in the property. Also, I have seen situations where the seller has borrowed money against the property without telling the buyer and then the seller has defaulted on his/her payments and the lender has foreclosed on the home and evicted the buyer. You have to make sure the contract for deed addresses these issues. And, get the contract for deed recorded in the Register’s Office to give “notice to the world” of your interest in the property.
2. Lease with an Option to Purchase
This method is similar to a contract for deed in the fact that no deed exchanges hands at the outset and the buyer is making payments until a set date in the future when the deed will be recorded. The difference is that the buyer is expressly listed as a tenant under the terms of the agreement. The lease term is set for a period of months or years at the end of which the tenant has an option to buy the property at a pre-determined price.
This method avoids potentially costly litigation that can occur if a buyer defaults and the seller is forced to evict. Under a contract for deed there has been litigation and Courts have held that a contract for deed should be treated like a deed of trust and the seller can incur significant costs and in some cases has even been required to pay the buyer back a portion of the payments because the Court determines that the payments were unfairly high if the buyer is being treated like a tenant instead of an owner.
On the positive side, a lease with option allows a seller to work with persons with credit issues without fear of going through a foreclosure or having a court order the seller to return any money to the buyer if the buyer defaults under the terms of the lease because the terms explicitly state that the payments are lease payments, not part of the purchase price. A buyer may consider the lease payments part of the purchase price if the purchase price under the option terms is calculated as if those lease payments went to reduce the total purchase price.
3. Deed of Trust
A deed of trust is what is used in Tennessee by institutional lenders like a bank as well as by individuals who do owner-financing for buyers. A mortgage in some states has a very different meaning than a deed of trust, but in Tennessee the terms are often used interchangeably. Under this method the buyer does get a deed at the time of “purchase”. Typically the buyer cannot pay the full purchase price so the seller gets a promissory note from the buyer stating that the buyer promises to pay the remainder of the purchase price over the course of a set number of years at a set interest rate. To protect the seller, the buyer also gives the seller a deed of trust which gets recorded in the property Register’s Office. If the buyer fails to make a payment, then the seller can foreclose on the property and sell it on the Courthouse steps. You can learn more about the foreclosure procedure here. Obviously, there are costs and procedures with a deed of trust that are not present with the other methods; however, a big advantage of a deed of trust is liability protection for the seller. Under a deed of trust you are no longer liable for any injury that may happen on the property. If a person slips and falls, they sue the owner (although you may still be named in the lawsuit your liability is much lower).
While these creative alternatives are used to avoid the cost and time involved with a traditional lender, it is still very important to get both parties’ intent down in writing so it is clear what your rights and obligations are beforehand. This is really an area where paying an attorney to draft the documents can save you a lot down the road should something turn sour. Have you ever had experience with these methods or other financing alternatives? How did it work for you?