Contracts for Deed: What They Are, and Why They Should be Avoided.
A couple weeks ago, I had a client, lets call her Martha, who called me with a small real estate issue. She told me that her neighbor had built on what she believed to be her property, and she was curious as to what sort of remedies were available to her. Upon hearing her complaint, I told her that the first thing we would need to do is review her title to make sure she did in fact own what she claimed. That review turned out to be easier said than done, as her property had been conveyed by series of family and friends through various nonconventional and owner-financed means. Martha currently claimed title through a quitclaim deed from her sister. It ultimately turned out that her neighbor had not built on the property. Instead, the property's boundaries were incorrectly reflected in the Bexar County Appraisal District mapping programs, a problem remedied by a quick trip to the BCAD office. Unfortunately, however, a boundary misunderstanding is just one potential pitfall of engaging in unconventional transactions.
Upon review of the title history, I told Martha that her biggest concern should not be her neighbor, but instead the conduct of past title holders. Over the years, title to the property had been passed through a series of conveyances known as contracts for deed. This risky method, also termed the "rent-to-own" conveyance, describes a situation where an owner offers to rent property to somebody, with the understanding that if they go certain time with no late payments or other issues, the seller/lessor promises to convey title to the buyer/lessee. In this sort of deal, the title is not transferred until the terms of the contract are fulfilled. This is distinctly different than a conventional mortgage situation, in which title is transferred to the buyer right away, and the seller (or financier) is given a deed of trust allowing them to foreclose on the property if there is a default in payment. In other words, while conventional mortgages give the buyer title right away, contracts for deed do not transfer title until the end of a lease period.
While many perceive this difference in title transfer as a potato-potáto distinction, there are several inherent risks present in the contract for deed situation. For one, as stated previously, another name for a contract for deed is rent-to-own. As one might imagine, the rights of a renter are generally much less than that of one who holds good legal title. A few years ago, I was involved in a case in which my clients were renting from a landlord under a contract that would grant them title after 10 year worth of payments. In the ninth year of the contract, my clients received an eviction notice stating they had violated the terms of the lease by engaging in illegal activities on the property. Whether the illegal activities occurred (frankly, I'm pretty sure they did), was not the main concern in the suit. The mere fact that someone who had diligently made monthly payments towards what they considered to be their home, only to be evicted like a common apartment dweller, was devastating to my clients. Luckily, executory contract laws allowed us to get the eviction suit dismissed, but only after a hearing in JP Court. The stress and money my clients incurred probably could have been avoided had the transaction been done pursuant to a promissory note and deed of trust.
Another pitfall of the contract for deed, which my client Martha experienced, is the potential failure of the seller to complete the contract by giving the buyer a deed to the property. Typically, contracts for deed are worded such that, upon completion of the payment schedule, the seller will grant a deed to the buyer. Again, that is distinctly different from conventional mortgages, where the deed is transferred immediately. Often in contracts for deed, the buyer will finish his or her payments, continue living in the home, and think all is finished. In reality, until the new deed is executed, legal title still remains in the seller. This final step can be very problematic if the sellers prove hard to reach, unresponsive, or uneducated on the subject.
In Martha's case, she had purchased the home from here sister through a quitclaim deed without any title research or insurance. After nosing around the county property records, I discovered that Martha's sister had acquired her title through a contract for deed. While she had finished her payments, the sellers had never completed the transaction by executing a warranty deed to Martha's sister. Not only that, but the original sellers had left San Antonio and returned to their native Mexico. Martha's sister had simply been mailing her monthly payments and had not had any contact with the original owners in several years. In this situation, Martha would not have actual title to her home until the original owners were found and the deed to Martha's sister executed. Until that happened, Martha's sister did not have any legal title to give, and Martha's quitclaim deed was essentially worthless.
Luckily, we were able to track down the original owners, and they had no issues executing the deed to Martha's sister as they had originally contracted to do. Thus, Martha's sister did get her title, and Martha's quitclaim allowed title to ultimately rest in her. Despite this relatively happy ending, it does not diminish the fact that all of this trouble could have been avoided by a more prudent real estate transaction. When I point this out to people, they often respond "but I have bad credit, so we had to do it this way." While I understand that the inability to get a conventional loan diminishes one's options in acquiring real property, it does not by any means force parties to engage in contracts for deed. If a seller is willing to look past a buyer's issues like credit, criminal history, etc., they will not lose anything by engaging in an owner-financed mortgage with deed of trust as opposed to a contract for deed. In either case, the seller can demand the same payment schedule, and they can still repossess the property if that payment schedule is not satisfied. The only difference is that the contract for deed offers the buyer much less protection during the payment period.
.There are several important takeaways from Martha's experience. The first is to always do title research before spending money on real estate. Even if you are going the owner-finance route, you should still get title insurance, or, at the very least, get a professional title opinion. Without it, you truly have no idea what you are paying for. The second is to avoid the contract for deed at all cost. Even if you have poor credit, or are avoiding traditional bank loans for another reason, there is no reason to subject yourself to the risks of renting to own. A more conventional deed of trust situation will still provide remedies to the seller in the event of a default, while affording the buyer many more rights and protections.