Contract For Deed Vs. Mortgage: An Overview
The fundamental difference between a contract for deed and a mortgage is the intent. To qualify as a mortgage – i.e., a secured loan – the parties must agree that title to the property will be transferred to the buyer at some point but that the seller retains a security interest (a mortgage) in the property until the note (or loan) has been paid. A contract for deed, on the other hand, gives the buyer initial title to the property at the time of purchase, allowing the seller to retain only the mortgage’s right to foreclose. This difference in intent results in the contract for deed being more similar to a lease or rental agreement than a traditional purchase and sales agreement. As a result, contract for deed agreements may not require a transfer tax when the contract for deed is recorded but a mortgage would.
In the event that the buyer under a contract for deed defaults , the seller’s remedy is the same as if that buyer had signed a mortgage and note. Under Florida Statutes, Chapter 702, the seller can proceed with a non-judicial foreclosure by filing a notice of default and forfeiture and giving the buyer six months to cure the default. If the buyer fails to cure the default, the seller can obtain a judgment of forfeiture and an order evicting the buyer.
These stated advantages in the contract for deed context are overstated in the current market context, however. Because banks are unwilling to lend to borrowers who have either inadequate credit or lack proof of income, the vast majority of contract for deed purchasers today are looking for short-term loans in anticipating of refinancing or an outright sale of the property. As such, sellers will experience the same default risk as they would if they instead had sold the property by way of mortgage financing.
Benefits of Converting to a Mortgage
There are a number of reasons the seller and the buyer may want to convert the contract for deed to a mortgage. After the contract for deed is executed, the buyer will likely want to get a mortgage which is a lower-cost method for financing the remaining debt on the home. The interest rates on mortgages are generally lower than the interest rates on contracts for deed, resulting in tremendous savings over the life of the loan.
The buyer may have these reasons in mind when they request, or at least it is fair for the buyer to state these reasons as its motive for converting. By converting the contract for deed to a mortgage, the buyer will be able to make low monthly payments and repay the debt over a long period of time. Many mortgage loans provide the borrower with an extended amortization period of anywhere from 30 years to 50 years. This can be very helpful for those who cannot otherwise afford a large loan payment. In addition, mortgage loans are often more flexible and affordable than contract for deeds because they can be refinanced at a lower-interest rate if interest rates go down at a later date. As noted above, the seller of the home will also benefit from converting the contract for deed into a mortgage. The seller would have immediate access to equity that otherwise might be inaccessible under a contract for deed. The conversion can prevent the buyer from skipping out on future payments and allows the seller to move forward if they wish to sell the property again. If the seller is no longer the owner of the property, then they no longer have any liability for the new notes or mortgages. In addition, once the contract for deed is converted into a mortgage, the foreclosure process will also allow the seller to collect attorney’s fees from the buyer if they default. Both the purchaser and seller may refer to the conversion of the contract for deed as a refinance, however, as we noted earlier, it is not a true refinance because the original contract remains active between the two parties until the contract is terminated and the deed is reconveyed to the seller.
Who Qualifies for This Conversion
In order to convert a contract for deed into a completely different type of loan, both the buyer and the seller must meet certain criteria. The seller must be able to accept the proceeds from the loan, while the buyer must have requisite credit and income to get the new loan. These aspects are a function of general creditworthiness. In order to convert your contract for deed into a mortgage, you (the buyer) need to acquire an appraisal for your property that meets the terms of a conventional loan based on the following: All appraisals must be performed by a Minnesota Department of Commerce approved and duly licensed Appraiser. Minnesota guidelines also require that all contract for deed holders obtain a Minnesota Mortgage Originator license in order to properly perform the conversion to a mortgage of restricted real estate, to ensure a legally compliant transaction.
How to Make the Change in 7 Easy Steps
Here is an example of the standard process involved in converting a contract for deed into a mortgage, including key legal and financial considerations:
Step 1 – Discussion
The buyer, either directly or through their legal counsel, proposes a conversion or refinancing to the seller, who is usually represented by legal counsel. Terms of the new loan are discussed, including the interest rate, loan amount, unpaid principal, and any other charges that will be outstanding, such as taxes, insurance, or assessments.
Step 2 – New mortgage terms
New mortgage terms, such as the interest rate, amount of the loan, and repayment period, are agreed upon and documented in a new promissory note.
Step 3 – New mortgage document
A new mortgage is drafted that contains the mortgage terms.
Step 4 – Supporting documentation
When applicable, supporting documentation is provided, such as a multicity credit report and a search and review of the real estate records to determine the ownership of the property, any collateral etc.
Step 5 – Buyer’s signature
The buyer signs the new mortgage document.
Step 6 – Financing statement
A financing statement is filed with the relevant local offices to ensure that the buyer’s encumbrance on the property is recorded against the property to protect failure to record a document in the United States patent and trademark office.
Step 7 – Executing document
The deed for the property will require execution and new recording to reflect mortgage terms.
Legal Implications and Risks
The conversion process can be complicated by a number of legal considerations. For example, many contracts for deed contain specific clauses that dictate the circumstances under which the contract can be converted to a mortgage, or they may require certain actions to be taken before a conversion can even be contemplated. Contract provisions that either entirely prevent conversion or set forth a series of steps necessary to effectuate conversion are often found in boilerplate language, which means that even if a deed has long since been recorded, there is a possibility that such a clause could end up haunting an unsuspecting owner or lender if left unaddressed. Before proceeding with a conversion of that type of contract, it is prudent to get an attorney involved to ensure the conversion will actually be valid. The conversion process may also be complicated by local zoning ordinances. Some states impose zoning restrictions on residential properties and, in that context, contract for deed arrangements are viewed as leases under state law. Because lenders generally cannot lend based on property being used as a leasehold, unless individual zoning requirements are addressed through a variance, it may be impossible to convert a contract for deed in a residential area into a mortgage . One way to avoid having to confront these issues is to check whether there are any zoning restrictions on the property before entering into a contract for deed arrangement, and, if so, whether such a contract can be converted. Finally, potential pitfalls can arise when conversion transactions involve loans that are subject to the terms of the Home Ownership Equity Protection Act (HOEPA) or the Truth in Lending Act (TILA) – statutory provisions that impose specific requirements and disclosures on lenders. There are different disclosure requirements for contacts made on or after June 1, 2013, but the general rule under both laws is that a conversion transaction is considered a refinancing and therefore the protections of HOEPA and TILA apply to the transaction if it does not involve a new borrower, a new lender, and no additional money is advanced. If the conversion transaction would require HOEPA and TILA disclosures, failure to provide those disclosures can severely complicate or even derail a conversion. The HOEPA and TILA statutes are rather complex, so any attempt to comply with their requirements should also be done in coordination with an experienced bankruptcy attorney.
Retaining an Expert for a Smooth Transition
One of the most important steps in converting a contract for deed to a mortgage is to retain the services of experienced and knowledgeable professionals, including a real estate attorney and a mortgage professional. These experts will play a pivotal role in ensuring that the conversion process is completed correctly and in compliance with all applicable legal requirements.
A real estate attorney can review the terms of the contract for deed and consult with the buyer to develop a plan for conversion. This may include negotiating any amendments to the existing contract and drafting the necessary mortgage documents. A lawyer can also provide advice on any other legal implications of the conversion and can assist in answering any questions that the parties may have about the process.
A mortgage professional can help the buyer to secure financing for the conversion. This may involve identifying the right mortgage products for the buyer’s needs and helping them to understand the terms and conditions of the loan. A mortgage professional will also play a key role in the transfer of the existing mortgage and the payment of closing costs.
Working with a team of experienced professionals will help ensure that the conversion process is smooth and seamless and that all potential issues are addressed in advance.
FAQs about Converting Contract for Deeds into Mortgages
The following are some frequently asked questions regarding the conversion process:
Q. How does the adjustment affect my payments? A. The payment should be adjusted to account for any loan payments, late fees and advances made on the contract not otherwise accounted for in the final settlement statement.
Q. Do I have to pay the calls and advances not otherwise scheduled on the contract now or can I include in the new mortgage? A. That will depend on the lender. Some lenders will request that everything be brought current and some will allow it to be paid off over a period of time.
Q. When I get the new mortgage can I stop paying my contract? A. Well that would depend on some factors. One , most lenders who do this type of transaction are very strict on when you are obligated to start making payments on your new mortgage. The lenders want you to start making the payments on the new loan immediately. The second consideration is you may want the mortgage to be current for title purposes. Lien priority is a big issue in subsequent transaction and having a current mortgage up front is what the lender wants. You can usually work out a payment extension with the lender if you need the time to pay off the contract.
Q. Can I modify the terms of the contract as part of the conversion process? A. It’s up to the lender. Most lenders have recommended guidelines that they have a hard time departing from. However, some lenders have better flexibility than others.
Q. Does it matter who holds the contract for deed? A. No, as long as the holder has the right to admit them into the conversion process. This group usually includes the originator and the assignees named on the contract for deed.
