Yesterday the StarTribune ran a story detailing several horror stories from contract for deed buyers. As I’ve noted on this blog and elsewhere in the past, the housing market downturn has spurred an increase in contract for deed transactions. These “seller financing” transactions can be the only option for buyers looking to return to the housing market after a foreclosure, short sale or bankruptcy.
The StarTribune story shows the pitfalls that befall parties to a contract for deed – particularly buyers – that enter into such transactions without a knowledge of how contracts for deed work and without the assistance of competent professionals, particularly attorneys.
I discussed my thoughts on the story with Mimi Schoneman on yesterday’s Red Hot Real Estate Show and you can listen here for that discussion (be patient as it takes a while to load).
Here’s a few more thoughts on the story and the points which Mimi and I discussed on the show:
1. A contract for deed is not a substitute for the many elements of a real estate purchase. There is a reason that a standard form purchase agreement – be it the Minnesota Association of Realtors (MAR) form or the Minnesota State Bar Association (MSBA) form – includes an addendum called the “Contract for Deed Addendum”; the parties to a contract for deed transaction should still enter into a purchase agreement, the buyer should receive a property disclosure statement and updated title work should be provided to the buyer. Further, as the article points out, in cities where “truth in housing” inspections are required, those requirements should be followed.
2. The contract for deed transaction should be closed with a title company. Remember that in Minnesota, where a contract for deed is entered into, legal title remains with the seller but equitable title passes to the buyer. Believe it or not, the buyer is able to purchase title insurance coverage for its interest, known as the “vendee interest”. However, a title company cannot and will not issue a policy of title insurance if it does not handle the closing. Further, Minnesota law requires that the contract be recorded within four (4) months of its execution. See Minn. Stat. §507.235, Subd. 1. If it is not so recorded, the buyer can be subject to a penalty equal to two percent of the principal amount of the contract debt under Minn. Stat. §507.235, Subd. 2. Utilization of a title company enables the buyer to purchase appropriate title insurance coverage for its vendee interest and ensure that the contract is recorded.
3. Any existing mortgages against the contract property need to be disclosed and dealt with. One of the individuals interviewed for the StarTribune story told of how she was being foreclosed upon because the contract seller had defaulted on a mortgage and filed bankruptcy. Most mortgages contain a “due on sale” clause that provides that a transfer of title without the lender’s consent allows the lender to accelerate the mortgage loan and foreclose upon the property. Because a contract for deed results in the transfer of equitable title, the due on sale clause is applicable. Rare is the lender that consents to a contract sale but if that does happen, the mortgage needs to be disclosed on the contract and the buyer should ask to receive proof of monthly mortgage payments being made and the right to make the payment directly and deduct any such payment(s) from the amounts owed to the seller if the mortgage payment is not timely made, in order for the buyer to protect his or her interest in the property.
4. The uniform contract for deed and addendum forms should be used. I have seen supposed contract for deed transactions where the parties only completed the contract for deed addendum to the purchase agreement – no further document was prepared, signed and/or recorded. That is a recipe for problems. There is a very good and detailed contract for deed form, along with an addendum, that any real estate attorney worth his or her salt can help the parties prepare in anticipation of closing (and should be signed ONLY at an official closing as noted above).
5. Which brings me to my last – and most important point – it is a good idea to be represented by an attorney in a contract for deed transaction. Using standard forms will not mean much if the parties do not understand them. The StarTribune sets out five ways that it proposes to reform contract for deed sales, all of which (of course) involve government action. We have laws already on the books regarding contracts for deed and there are scores of real estate attorneys – myself included – who are quite familiar with them. Had the parties involved utilized our services (and from the sound of it I am assuming that no attorneys were involved, particularly on the buyers’ side), the problems could have and likely would have been avoided.
Do we real estate attorneys cost a bit of money when we represent a party? Of course. However, the headaches we prevent – some of which are evidenced in the StarTribune story – are likely more expensive than the cost to hire us to do it right.
Kudos to the StarTribune for highlighting some of the issues that befall parties who enter into complex real estate transactions without appropriate advice; however, before we pass new laws, we should be advocating that folks seek counsel from those of us familiar with the ones we have.