Eight fundamentals of a real estate contract

The Real Estate Contract, or Land Contracts or Contract of Deed, can be a good tool for real estate investors to receive higher income (generally higher than rental income by around 30% to 70%) during a few years during the term of the contract.

One of the main disadvantages of the Real Estate Contract compared to the “Long Term Lease to Own” is that the sale price is established, most of the time, at the current market value without giving much time to the owners. real estate investors to get out of this situation. real estate recession. However, depending on the interest the buyer is willing to pay (the *spread* in the case of a wraparound mortgage) and the reduced or eliminated property tax and insurance payment, investors can expect considerable cash flow. each month, which should offset the loss of potential capital appreciation. One caveat to this strategy is the buyer’s ability to *prepay* the mortgage. See below for more discussion.

Real Estate Contracts are common in some states, they are called Land Contracts or Contracts of Deed, but they all represent the same thing: a way of selling a property where the buyer “borrows” from the seller for financing instead of borrowing. from a bank.

Within an agreed number of years, the buyer is expected to be able to qualify for a loan. At that time, they will take out a new mortgage and pay the amount the land contract requires. Real estate contracts vary widely from transaction to transaction, however the basics of contracts are generally:

1. Seller retains legal title and Buyer receives equitable title

The buyer will not receive the deed to the property until the full amount the seller financed is paid in full. The seller remains the owner as long as the buyer makes the payments. Transfer of legal title is always accomplished by a separate deed of conveyance, usually a warranty deed, which is deposited in escrow when the contract is signed.

The contract transfers an interest to the buyer, known as “equitable title.” The buyer signs a special warranty deed that is deposited in escrow along with the seller’s warranty deed. The seller may recover equitable title from the buyer in the event of a buyer’s default by giving proper notices (usually 30 days) and terminating the contract. It is a much faster process compared to the foreclosure procedure.

2. The purchase price is often set at current market value

The Purchase price is negotiated between the Seller and the Buyer. Properties sold on a land contract do not necessarily sell for more, because the buyer takes great risks to receive financing from the all-important owner. On the other hand, Owner can usually recover the title/deed from Buyer fairly quickly in the event of Buyer’s default and retains all down payment and interest paid.

3. Initial payment

Down payment must be at least 7% to cover closing costs (6% agent commissions and title/escrow fees). The higher the down payment, the more committed the buyer is and the less likely they are to default.

4. Balloon payment

A balloon payment is the term used for a lump sum, the final payment of the contract. Blanket clauses usually require that the final payment be made by a specific date. Failure of Buyer to make a lump sum payment when required will constitute a breach of contract.

5. Interest Rate and Monthly Payment

Typically, the amount financed by the owner (purchase price less down payment) is amortized over 30 years payable monthly. The remaining balance will be reduced each month with the payments made by the Buyer. Depending on whether the seller has a mortgage, the interest rate must be high enough to cover the owner’s monthly payment. We’ll discuss the wraparound mortgage or all-inclusive deed of trust (AITD) in the later blog. Typically, the interest rate is set at between 1% and 3% on top of the 30-year mortgage.

6. Taxes and Insurance

Most of the time, the Buyer is responsible for paying property taxes and insurance. Buyer is required to pay approximately one twelfth of estimated taxes and insurance along with each monthly payment toward escrow. The trust then, in turn, pays for insurance and property tax. This is the surest way to ensure important property taxes and insurance are paid.

The insurance policy must be changed from an owner’s policy to a renter’s policy and the beneficiary must remain the seller who holds legal title during the term of the Contract. Buyer must maintain their own insurance covering personal property.

7. Defaults

If Buyer defaults on a significant part of the contract, Seller may be entitled, after notifying Buyer in writing of the exact nature of the breach, to treat all payments already made under the contract as mere rental payments made by Buyer. Buyer. If the breach continues, the Seller has the right to declare the remaining balance due and payable, and if the breach is not corrected or the contract is not paid in full, the Seller may initiate proceedings to recover possession of the property. Improvements made to the property by Buyer become the property of Seller.

8. Provision of advance payment

For real estate investors who like to receive a positive cash flow to offset the sale of the property at current market value, be very careful that the buyer can usually make advance payments to reduce the principal, which reduces the interest you can charge. or even worse, pay off the entire loan to fulfill the contract early. Paying early will be detrimental to your cash flow positive strategy to improve your bottom line. You can alleviate this risk by setting a prepayment penalty or declining the prepayment in the contract. Alternatively, you can request that the prepayment be applied to the original loan (wrapped loan) first, not the owner-financed mortgage. So, as the seller, you can pay off your home mortgage faster than the buyer. This is to greatly improve your performance.