'Contract for deed' problems; beware
By David S. Jones, Real Estate Center at Texas A&M
Aug 13, 2008
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Quite a bit of newspaper and website space has been used to warn consumers about so-called predatory lenders.  But Dr. Jack C. Harris, Real Estate Center research economist, says unscrupulous lenders are not the only ones who have found ways to prey on unsuspecting homebuyers. There are “predatory sellers” too.

“These predators take advantage of those with limited knowledge and means,” Harris says.

One technique used to sell low-cost homes to buyers with no established credit is through use of a contract for deed. In fact, exploitation of contracts for deed became so widespread that the Texas Property Code was changed in 2001 in an effort to stem the predatory tide.

Contracts for deed often are called “land contracts” because they are a relatively common method for selling undeveloped tracts. A contract for deed essentially allows the buyer to pay for the property in installments. Each installment includes an interest and principal payment.

“The main difference between a contract for deed and a mortgage loan used for most home purchases is that a contract for deed does not give the homebuyer a legal interest in the property until the entire principal is paid,” Harris says.

This arrangement gives the seller maximum security and is appropriate for sales to buyers with no or bad credit histories.

The problem is that predatory lenders have used the contract for deed to hide high interest rates and inflated prices while avoiding the consumer disclosures and safeguards required when commercial lenders are involved.

“Even worse,” Harris says, “is the practice of closing out these contracts after the buyer has made most, but not all, of the payments.”

Legitimate sellers often work with buyers faced with default. Predatory sellers, however, actually look for violations — or even fabricate them — in hope that the buyer has failed to keep good records. When the buyer “defaults” on the contract, the seller gets the home back, and the buyer is left with nothing.

Another technique predators use involves buying poor quality homes at rock bottom prices, slapping on some cosmetic improvements and selling them to unsuspecting buyers at inflated prices.

“The sellers commonly offer seller financing and techniques such as taking the buyer’s existing house as a trade-in,” Harris says. “These practices help disguise the fact that the buyer is overpaying for the home.”

Harris warns that predatory sellers are adept at configuring the sale so buyers end up paying less in monthly home payments than they did in rent. Ads promising low down payments don’t mention that the earnest money deposit — usually several thousand dollars — is nonrefundable.

Many buyers are satisfied with their predatory loan until they have to sell or something happens to the home. That’s when they discover the property is worth much less than they owe on the loan.

“Stopping such predators is not easy,” Harris wrote in the July 2004 edition of Tierra Grande, the Center’s quarter magazine for Texas real estate licensees. “Perpetrators generally are unlicensed and beyond the jurisdiction of state authorities.”

People caught in a predatory sales trap may need to file a civil lawsuit, but they often are financially unable to do so.

For more information, see “New rules Govern Contracts for Deed.”