“Creative Financing” Pros & Cons
Among the more common “creative financing” alternatives in Virginia are the “Contract for Deed”, or “Land Contract”, and the “Land Trust”. Creative financing often becomes necessary when you have a Seller very motivated to Sell, but who who has very little equity and does not want to do a Short Sale or rent the house and take on the maintenance obligations of a normal landlord. In previous Blog entries, we’ve talked about one of the bigger pitfalls to “creative financing”, and that is that it may give the Seller’s Mortgage Lender(s) the right to foreclosure for a violation of the “Due on Sale Clause.” If the likelihood is low of the Buyer quickly being able to refinance, sell, or otherwise come up with the money necessary to payoff the Seller’s mortgage, the Buyer might be well advised to just consider using a Lease with an Option to Purchase.” That generally avoids violating the lender’s rules against conveying title. On the other hand, if being in a position to claim the most possible income tax deductions is important to the Buyer, then something more than a Lease is probably required. Seek your own experienced tax advisor on any matter pertaining to tax consequences!
Our experience with Land Contracts is extensive. We review or close them on a regular basis. The one thing thing they all have in common is that they all have nothing in common! Each “real estate investor” or each distressed Seller trying to offload the responsibility to make mortgage payments is prone to find their own set of forms and uniformity is elusive. Of all the real estate related practices in Virginia in which you must have your own attorney to safely navigate the contract, Land Contracts are at the top of the list. What you don’t know very much can hurt you.
The foremost consideration is the handling of money . . . how much the Buyer will pay down, pay per month, pay to what account (lender directly or the seller as a conduit?), how much applies to the sales price, what step(s) must the Buyer take to be entitled to get title in the Buyer’s name, and is any of the money refundable to the Buyer if the Seller defaults? As long as the Seller is on title, things are very much “out of control” for the Buyer. It is entirely possible that the Seller can allow tax liens, judgment liens, Home owner association liens, third mortgage liens, or other title issues to attach to the title and not notify the Buyer. A good legal review and strategy will make sure there are ways to protect the Buyer from these liens and other title problems.
But matters of how and how much to pay to whom, keeping title clear, and having logistics worked out in advance for monthly payments and the final balloon payment are not the only issues to address with your attorney before signing “Land Contract” documents. Suzy Rook, Real Estate article editor, has a very thorough laundry list of things to consider before entering into a “Land Contract.” In her article:
Beware toxic transactions: Homebuyers urged to be careful about contract for deed offers
Suzy says: “With a contract for deed, buyers often do not fully understand the extent of their obligations, all of the costs they must pay and the risks they are incurring, including how quickly they can lose the home and all the payments they have made.” If you are considering a Land Contract or a Land Trust, do consult an attorney . Both have positive possibilities for a potential homebuyer with a current inability to qualify for a mortgage of their own. (1) Limit your non-refundable deposit; (2) Make sure you understand your obligations from maintenance to making the final payoff; (3) Know your grace period for late payments and the point at which the Seller can take all your money and cancel your lease; (4) Make sure you really don’t qualify for your own mortgage; (5) Make sure you don’t agree to overpay, i.e., get an appraisal on the property; and (6) Make sure to get a full title search. There are some reputable real estate investors who legitimately “flip” real estate using Contracts for Deed or Land Contracts, but if they are only an intermediary of title and not the owner, you deserve to know that.