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Advantages and Disadvantages To Home Buyers

How contract for deed is a great option for buyers when done right
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Advantages and Disadvantages In Contract For Deed

Just what are the advantages and disadvantages of a contract for deed to the buyer in a real estate transaction?

For many buyers who are considering contract for deed the only other option is to rent for many years. Therefore, it is prudent to consider all the benefits of homeownership as well.

Keep reading below to find out how this can be an excellent option to achieve homeownership when bank financing is not possible.

Or check out our what is contract for deed page that goes into more detail on typical terms and how it works.

What Are The Advantages of a Contract for Deed to Buyer

#1 – Bad/No Credit is OK!

A individual’s credit and/or credit score is not part of the loan qualification process with contract for deed financing. No credit check is performed, and it is by far the #1 reason home buyers in Minnesota use this financing option when it becomes clear a bank mortgage is not an option.

That is because contract for deed is meant to be an alternative to bank financing.

The seller/owner in a contract for deed is compensated for the added risk of bad credit by charging a higher interest rate and down payment. That is why contract for deed should always only be used when a bank mortgage is not feasible.

When speaking about credit it should also be noted a contract for deed is different than rent to own where credit still matters quite a bit. A rent to own is still a lease agreement, and many buyers researching contract for deed can confuse the two.

The ability to get a loan with bad credit is also advantageous to first time home buyers who don’t always have the credit history needed to qualify for bank financing.

 

#2 – Flexibility on Qualifying Income

Besides bad credit, the flexibility on qualifying income for buyers is the #2 reason individuals choose contract for deed.

Did you know that the self employed are the number one group who utilizes contract for deed financing? 

Gig workers, 1099, those where tips are used (such as restaurant industry), or essentially anyone else who is not W2 falls into this niche group as traditional banks do not have a loan product tailor made for this category. This is due to banks qualifying taxable income vs. gross income, which when factoring in tax deductions for the self employed does not show enough income.

Contract for deed financing can still be helpful to W2 earners who are brand new out of college, or switched industries/have wide gaps in employment history. Most lenders like to see two years of employment history, but this is not necessarily needed with contract for deed as the seller can make the decision

#3 – Gain Equity Appreciation “Tax-Free” When Home Values Rise

Another important advantage to buyers is gaining equity when home values rise, and with current tax laws capital gains on a sale can be tax free for those who use their home as a primary residence. When selling a home the limits are very generous up to $500,000 for married couples.

There are not many investments a person can make where profits are tax-free, but a primary home is one of them; especially when compared to renting.

It is not just rising home prices though, because since a buyer own’s the house any remodeling projects like a kitchen or bathroom can also increase the value. This makes contract for deed very advantageous for homeowners that don’t mind building a little sweat equity into their home.

#4 – “Locking in” a Fixed Monthly Payment Now vs. Paying More Later

Buyers who are years away from being able to get a bank loan will miss out on rising home prices if they turn to renting, and then eventually be forced to purchase a house at a much higher price then what they could buy it for today.

This in turn means a higher monthly payment. When home values are rising, buyers risk getting priced out of the market as their ideal home gets more expensive, and eventually the monthly payment becomes too high for them to afford. In real estate we talk about this commonly as home affordability.

“Contract for deed financing allows borrowers to purchase a home and lock in today’s prices”

 

#5 – Interest & Property Tax Deduction

Buyers in a contract for deed can claim interest paid on the loan, along with property taxes, on their personal income tax returns every year. This is a major benefit of home ownership as it allows many people to realize a larger tax refund.

Just make sure to claim homestead status immediately with the county once the contract for deed is recorded as this also will lower the property tax bill. 

Buyers should receive a statement from the county annually showing property taxes paid. The seller will provide a statement showing the amount of interest paid to the buyer; usually in January when other tax documents are being sent out.

#6 – Stop Throwing Money Away On Rent

Contract for deed financing, just like a bank mortgage , will have the buyer making monthly principal and interest payments. Along with rising home values the actual loan amount shrinks over time.

Another benefit? Many landlords raise rent prices every year whereas with contract for deed financing the interest rate is fixed. This means the monthly payment will not change at any time during the loan term.

Even with higher interest rates in a contract for deed financing the actual monthly payment tends to be very close to market rent, which besides all the other benefits of homeownership make contract for deed a no-brainer option versus renting.

Many buyers also enjoy the fact they don’t have to move multiple times, as well as owning the home compared to dealing with property management companies whenever something needs to get fixed.

#7 – When Religious Beliefs Do Not Allow Mortgage Financing

Contract for Deed is highly advantageous where an individual’s beliefs prevent them from obtaining mortgage financing from a bank, because the seller is still legally the owner via legal title until the loan is satisfied. 

What Are The Disadvantages to Buyer in Contract for Deed?

Now that we have covered all the advantageous to buyers using contract for deed there are also some disadvantages that should be considered. 

#1 – Less Protections to Buyers Compared to a Mortgage

If a buyer defaults on their payments under the contract for deed terms, and is unable to get current within the agreed upon time frame, the seller has the right to terminate the contract for deed.

With a mortgage in Minnesota a buyer may have up to twelve months, or sometimes longer, to either get caught up on payments or sell the home. Contract for Deed in contrast can take as little as four months, but the buyer is still able to sell the home in order to retain their equity.  

Since contract for deed is a private sale between buyer and seller the responsibility of determining the ability to repay the loan falls largely on the buyer’s shoulders.

Although it is in the seller’s best interest to ensure the contract for deed transaction is successful, the buyer must also be confident they are not getting into too high of a monthly payment. Since a credit report is not typically pulled in a contract for deed buyers who have a lot of debt especially need to pay attention to their monthly payment.

If buyers are interested to learn more about the cancelation process in contract for deed head over to our frequently asked questions page where this topic is discussed more in depth.

#2 – Contract for Deed Homes Typically Come with a Higher Price Tag

A buyer can expect to pay a higher sales price for a house using contract for deed financing than through a mortgage. 

There are two main reasons for this:

  1. Supply and Demand – in Minnesota finding contract for deed homes is extremely rare, which allows the seller to obtain a higher price. The good news is our financing program solves this issue for buyers.
  2. The Seller Forgoes a Lump Sum Payment – In a normal transaction using a mortgage a seller would get fully cashed out at closing receiving 100% of the proceeds from the sale. In a contract for deed the seller forgoes this, and instead receives payments over time since they are also financing the buyer. This is not always and advantage to the seller, so paying a higher sales price entices them to entering into a contract for deed.

Conclusion

Utilizing a contract for deed in Minnesota to achieve homeownership can be very advantageous to buyers; especially when compared to renting.

It should be reiterated that contract for deed should only be used as a last resort, because obtaining bank financing is always going to provide the best terms to the buyer. It is for this reason contract for deed is advantageous when buyers are years away from getting a mortgage.

In order to have the highest chance of success it is important buyers choose to work with the professionals who understand all the legal aspects of contract for deed.

 And when in doubt it is always recommended to seek legal advice through a real estate attorney if there are any concerns about the contract for deed transaction.

 

 

"When The Banks Turn You Down We're Here to Help"

Chris-Block

-Chris Block Owner & CEO

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