What is a Contract for Deed?
A contract for deed is also referred to as an agreement for deed, an installment land contract or a land sales contract. Regardless of the name, this arrangement allows a prospective buyer to purchase residential property when mortgage financing might not otherwise be available. A seller agrees to sell a home to a buyer and the buyer makes installment payments to the seller until the balance of the purchase price is paid in full, at which time the seller delivers the deed to the buyer, who then assumes ownership of the home. While the property remains in the name of the seller, the buyer enjoys the privileges of ownership, including the right to live on the property, make repairs and improvements, pay property taxes and occupy the property as a residence.
The installment payments are mutually agreed upon and function more like rent payments. The contract payment terms are similar to those associated with a traditional home loan, but the financing offered through a contract for deed often doesn’t require a large down payment upfront. While monthly payments are typically lower than those associated with a standard home loan, the buyer must understand that the obligation to make the payments and reside on the property is binding for the duration of the contract period. Essentially, the buyer is making monthly payments for the privilege of using the property, but the deed will not be granted until the contract is fulfilled .
For the seller, a contract for deed functions as a means of transferring ownership with a purchase contract that may include protection from the deficiencies of the buyer. An essential element of any successful contract for deed is a clearly defined purchase price, down payment, interest rate, loan period, monthly payment amount and all the responsibilities of the buyer with regard to maintenance, repairs, taxes, insurance and utilities. Because the buyer is not purchasing the home through a traditional mortgage, the buyer does not build equity in the home during the contract period.
Missed payments often result in immediate termination of the contract and a possible loss of the property by the buyer. The specific circumstances that would lead to termination should be explicitly detailed in the original contract agreement. Buyers considering a contract for deed must understand that if the contract terms are not followed, the buyer could lose both the property and all the money that has been paid to the seller during the contract period.
Because a default on the contract could also lead to foreclosure by the seller, a contract for deed is more beneficial to the seller than to the buyer. For the buyer, a contract for deed should be carefully examined and entered into with caution.
Contract for Deed Advantages and Disadvantages
Contract for Deed, or Land Contract, offers several advantages to all parties involved. Seller obtains cash flow and can usually charge higher interest rates than on typical loans. Buyers pay lower closing costs and avoid many of the stringent credit checks required by conventional lenders. Both parties have more control over their investment as the contract is not held by a bank or other lending institution. But with this flexibility there are also risks. With a Contract for Deed sale, the buyer does not hold a deed until the completion of the sale terms. This means that the buyer has no immediate equity but also assumes no immediate responsibility. The seller, in effect, becomes a money lender with the risks associated with that role, including assuming liability for any pitfalls that would come with legal actions by the buyer. Because the deed still belongs to the seller, they are legally able to evict the buyer if they miss a payment, which can become a costly legal matter. Buyers are specifically vulnerable to the risks of a Contract for Deed. These sales usually do not allow for inspections and do not automatically guarantee an accurate property description. A promise to make certain improvements to the property may not be fulfilled. Furthermore, the deal may not be a good one for the buyer, and they lose the chance to walk away. An unscrupulous seller may even foreclose for a minor missed payment, leaving the buyer with nothing and out thousands of dollars. Sellers are equally vulnerable to the risks of a Contract for Deed; they have no guarantee that the buyer will stay faithful to the terms of the contract, including maintaining the premises or paying property taxes. This can jeopardize their own credit if payments are missed and the seller ends up paying the bill to preserve the property. Lastly, the buyer may deal untruthfully and the seller may be left with no recourse.
Contract for Deed Legalities in Illinois
In addition to the prohibition against a borrower acquiring multiple properties at once, the statute forbids the use of the Contract for Deed to circumvent any other provision of the Code or any other law. While this type of language is frequently used to outlast a change in law, the problem is that these prohibitions don’t just apply to Chicago. They are blanket provisions that are not limited to Chicago – they apply statewide – and the burden is on the buyer to ensure that the provisions of Section 33 are met.
The second requirement of Section 33 is the provision requiring that the purchaser must be informed that the property is being sold without warranty or representation – against the world – by the seller. Why? Because this applies statewide.
The Chicago version of this contract used to allow a purchaser to notify the seller that it was waiving this provision and would not seek a title policy or title insurance. When this happened, closers would issue exceptions to the title policy titled "without warranty." These exceptions are rescinded when the loan closes. Under the Chicago Ordinance, this notification is now only effective as it relates to the deed conveying the right a title holder has to possession. In other words, it no longer negates the warranty anywhere else in the transaction. More importantly, it is no longer invocable by the buyer alone. The seller must consent to the waiver of the "without warranty" language.
The third requirement of Section 33 is that the seller ascertain that the purchaser is given a copy of the contract for deed before the agreement becomes binding. This is a little-known requirement. In the residential environment, it is practically impossible to ascertain when a contract is binding. It is important to recognize that the definition of the term "contract" in the contract for deed statute is the contract for deed itself that is referenced to subparagraph 10 of Section 10 of the Illinois Uniform Commercial Code. The same Statute of Frauds we discussed for a mortgage, encumbrance or contract for deed fits here. The Statute of Frauds requires that a contract for real estate be in writing and signed by the person to be charged with the agreement. For a residential contract for deed, this would amount to the signature of the buyer and seller – for each party who is to be charged with the agreement, and their agent(s). Therefore, the contract is not binding until it is signed by all parties to the contract.
However, in order to comply with Section 33, the seller must give a copy of the contract to the buyer prior to it becoming binding – ahead of that statutory requirement. How to comply? As a practical matter, this means that the buyer must have sight of the contract prior to closing – not simply receiving it in the closing package via their attorney. This is something that is routinely overlooked in our industry. In the rush to get a residential closing done, title agents almost never contact the buyer to confirm that they are satisfied with their copy of the closing package. For insured transactions, these problems do usually raise their ugly head from time to time. But from the standpoint of residential transactions, under the Contract for Deed Ordinance’s statutory language, it must be addressed preclosing.
The fourth requirement of Section 33 is that the seller is required to provide a complete copy of the recordable contract for deed to the buyer upon execution thereof. This means that the seller must record the contract under the Cook County Property Address program, and charge the buyer to record it. This is the only way to comply with Section 33, so it is what has to be done.
Illinois Contract for Deed Step-by-Step Process
Negotiating and signing a contract for deed in Illinois follows a standard process, although some of the terms may be negotiable. As with any real estate transaction, effective negotiation is crucial to arrive at an agreement both parties are happy with. The steps involved in creating a satisfactory contract for deed are as follows:
Negotiation – Once the buyer and seller have come together on a basic property sale, negotiation begins on the specific terms of the contract for deed. Typically, this involves discussions about how much money will be put down for a down payment, as well as what the monthly payments are going to look like, who will be responsible for repairs and taxes, whether the buyer will require financing for renovations, how long the agreement will last, and the required interest rate.
Signing – After it has been agreed in writing that the terms are satisfactory, the next step is to sign the contract and make any payments that have been agreed upon .
Recordkeeping – Once the deal is done, the seller must keep careful records of all payments made by the buyer. These records will lessen the chances of a dispute over late or missed payments, which could jeopardize the deal. There is no need to file a contract for deed with the state, but both the buyer and seller should retain a copy of the signed agreement and any other documents related to the transaction for their own protection.
Since few contracts come together exactly as they are supposed to, there is often a fair amount of back and forth between buyer and seller before terms are finally settled. When it comes to creating a contract for deed in Illinois, an experienced real estate attorney can be crucial to helping negotiate the best terms for both sides, as well as in keeping accurate records and ensuring documents are in order.
Common Mistakes and How to Prevent Them
Buyers and sellers must be careful when entering a real estate transaction where a buyer pays for property in installments. The first hazard is the risk that the buyer will ultimately not make all the payments under the contract and fail to use and maintain the property as agreed. This could lead to the seller not receiving the full purchase price by the end of the installment period and the buyer losing the property through forfeiture or foreclosure. By the time this scenario arises, the seller may have acquired other real property, become less willing to issue a refund of all amounts paid in, and/or made upgrades to the property that may not be easily undone. Circumstances like these make a seller less receptive to a request from a buyer to apply some or all of the payments made under the contract to a refund of a down payment or the return of a portion of the monthly installment payments upon the buyer’s request. It can also lead to a demand for more than the arguably fair and reasonable amount of payments made in before the release of the seller’s remaining interest in the real property.
The risks to a buyer are that, more likely than not, the buyer will have already made payments at the time of the occurrence of the events described above. Unless specific terms are included in the contract, the buyer will not be entitled to receive a refund of the down payment and be able to continue with the contract for what the buyer would like to pay in the future. In short, if the seller wants all of the buyer’s money for the property, but the buyer can’t make the all of the payments, there are only two options: (1) the buyer defaults giving the seller the right to terminate the contract or forfeit the down payment; or (2) the seller and buyer agree to some other resolution of the issue such as a reduction in the amount or time of future payments, or a refund of a portion of the payments made allowing the buyer to keep the property, a different property, or some other substitute for the property. Any time the parties to a contract for deed are able to reach an agreement that provides for something different that the terms of the contract, there should always be a written amendment or modification to the contract.
Contract for Deed Alternatives in Illinois
In considering alternatives to a CFD, we find that there are several possibilities. The method of "renting with the option to purchase" is very popular. Here, the seller leases the property to a prospective buyer for a period of time, and allows the buyer to purchase the same property during or at the end of the lease period. The purchase price, monthly lease payments and how the rent will get credited broadly resemble those in the Contracts for Deed. Also here, like with a CFD, the seller retains legal title to the property during the duration of the lease, even if the lease is "recorded" (meaning, in effect, filed with the county recorder of deeds) . The point of this is to give the lessee an interest in the property somewhat akin to ownership even while the lease is in effect, and this can be an important fact in if/when the lessee tries to get financial assistance to purchase the property. What makes this different from those CFD instances is that in this case, as with a mortgage, the lessee gets equitable title (like, in our example, most likely an "equitable owner" of the land) after fully paying all contracted terms. Any installments paid in this case would be regarded as "principal and interest" payments, similar to what the homeowner pays to a lender in a mortgage arrangement. In addition, unlike a CFD, the capital gains exemption that applies to a principal residence called the Code Section 121 exclusion under Internal Revenue Code Section 121, would be available to the seller for the sale under the "rent-to-own" concept.