In the realm of real estate, CFD stands for ‘Contract For Deed’. This is a type of sales contract that facilitates the purchase of property to buyers who are unable to procure finances through traditional means such as mortgage loans.
The buyer makes monthly payments to the seller and will only receive the title to the property once the complete payment has been made. This means that the seller retains the title of the property until all dues are clear.
Other names for CFD transactions
Real estate experts also refer to Contract for Deed with other names including:
- Creative financing
- Land Contract
- Simple Land Contract Purchase Agreement
- Land Sales contract
Why is the word “land” associated with the term CFD?
You will notice the word ‘land’ often used with the term CFD. This is because contracts for deeds were originally used to purchase land infrastructure such as ranches, farms, mountainous property, and grazing land were used for development.
Most lenders are not willing to lend funds on land because it is more volatile than residential and componential properties (which have proven to be more stable in terms of market value). Raw land, by comparison, is subject to various market factors such as laws related to changes in usage, problems with the economy, and zoning laws.
Bankers have traditionally steered clear from raw land because of the higher risk. This led to the use of Contract for Deeds, especially after the 2009 real estate crash, leading to stricter lending rules by lenders.
Sellers and buyers both needed a means of proceeding with their sales, and the Contract for Deed was used as a suitable means of facilitating this transaction. Studies show that the utilization of Contact for Deeds continues to soar because of its convenience.
Laws vary from state to state
The laws that regulate CFDs depend on the state and may even vary from one county to another. If the buyer or seller is hoping to use CFDs, they should be well informed about the potential legal ramifications before entering into such an agreement.
Minnesota, for instance, requires all transfers of property to be recorded with the county’s office within four months. Failure to meet the requirements may result in a fine.
The seller may also be required to list out any known defects with the house that could affect its value. This includes plumbing problems, pests, malfunctioning appliances such as air conditioning, structural issues, leaks, and others. The disclosure should also include any construction or demotion projects planned for the community.
In nearly every case, there is no requirement for a down payment in CFDs. This allows the buyer to start making monthly payments to satisfy the terms of the contract.
It is worth noting that under most Contract for Deed sales, the buyer takes over the responsibility associated with property ownership, these include insurance, property maintenance, and even property taxes. One advantage that buyers have is the ability to make adjustments to the property such as home improvements and major makeovers.
What information should a contract for deed include?
A contract for deed must include the following information:
- Identities of the seller and buyer
- The legal description of the property
- Selling price
- Terms of payment plan
Furthermore, the CFD should include specifics related to:
- Property insurance
- Property taxes
- Down payment, if any
- Loan interests
- Late penalties
Pros and cons of CFD
There are pros and cons to CFD in real estate, whether you are a buyer or a seller.
Pro: No need to qualify for mortgage
If the buyer is unable to qualify for a mortgage because of bad credit or past bankruptcy, lack of income, or employment history, they can use a contract for deed as a good alternative to investing in real estate.
This requires the prior approval of the seller to do such a transaction. Contracts for Deeds also give buyers and sellers more wiggle room to negotiate a down payment. They don’t have to concern themselves with miscellaneous costs usually associated with mortgage payments such as origination fees, closing costs, and other expenses
Unlike mortgages, where failure to keep up with payments may result in foreclosure, the seller does not have the right unless the buyer agrees to include that in the contract.
Contracts for Deeds have been especially useful for buyers who would otherwise not qualify for traditional bank loans due to reasons such as:
- Insufficient collateral
- Poor credit rating
- Lack of employment history
- High person debt to income ratio
- Insufficient down payment
- Changes in employment
Con: Buyer doesn’t get access to property until payment is complete
This is a big disadvantage to buyers because they will not have access to the property until they can pay the agreed-upon money in full. Depending on the buyer’s income, completing the payment of the house may take several years. Furthermore, there is an inherent risk associated with this transaction, in that, if the buyer fails to complete payments, they can not only lose the property but also the money they have already put into it.
Another risk to the buyer is that they will have to arrange for their accommodations elsewhere since they do not have access to the property. That will require access to even more free cash, which may defeat the purpose of going through the Cash for Deed method of purchasing a house.
Pro: More potential buyers
Since more buyers can qualify for purchasing the house, the seller has the luxury of choosing from a larger pool of potential leads. Most of these buyers who don’t qualify for a mortgage are more than happy to put up with years of payment before gaining access to the house. This means that the seller could use the property until payments have been made while using the cash flow from the sale to invest in real estate.
The process is usually faster than a sales process. In case the buyer goes into default, the seller may have the ability to immediately terminate the contract, without worrying about any legal hassles involved for a mortgage holder to foreclose on the home.
Con: Few protections in place
Contract for Deeds traditionally lacks any protections in place that are usually available through conventional mortgage systems. These measures have been included to protect the interests of both buyers and sellers.
One example is that most lenders require a title company to be employed to ensure that the title is unencumbered and valid. In case the property is unencumbered, what are the reasons for this? Does the seller have prior outstanding loans against the property?
In case the seller’s property is mortgaged, the new buyer will find themselves in a precarious potion should the seller default. So if the seller’s lender decides to foreclose on the property because of failure to make timely payments, the buyer, under the new CFD, could lose the property as well as all of their equity.
Pro: Faster speed of execution
One of the biggest advantages of a Contract for Deed real estate transaction is that it can be executed right away. It may not be in the best interests of either party to move quickly, but they can get this done. By contrast, most conventional lenders will take several weeks just to approve the loan process.
The expedited nature of the transaction can be beneficial to both parties. The seller can find access to cash flow and facilitate their obligations. Meanwhile, the buyer can complete the transaction quickly in case they have to vacate the property they are currently living in, probably due to the termination of a lease.
A CFD can also provide the seller with an alternative way to sell their property if they were unable to find buyers who qualify for traditional financing. They may also realize some property tax savings from selling the property in installment payments instead of realizing the entire gain in one year. Furthermore, the seller retains the title to the property as security until they are paid in full by the buyer.
Pro tip: Make sure to hire a counselor for assessment of your finances to see if you qualify for conventional loans such as mortgages. The housing counselor can also give you advice on how to improve your credit score.
Wrapping up – Contract for deeds is flexible for buyers and sellers alike
The best part about Contracts for Deeds is that the terms and conditions are flexible, depending on what the two parties decide to work out between them. Both parties can control the payments, down payments, as well as time. Depending on the exact terms, the contract may be favorable to either buyer or seller. What counts as a benefit for the buyer may be a con for the seller and vice versa..