The Sales Agreement
HOW TO ASSUME THE NON-ASSUMABLE LOAN CONTRACTS FOR DEED
Interest rates move up and down but there are many low interest loans already in place. Unfortunately, most are not assumable. That means a buyer must apply and qualify if he wants to take over a seller's existing loan. In addition, the lender may raise the interest rate to market. This procedure can be as restrictive, time consuming, expensive and burdensome as applying for a new loan. If the buyer takes over the loan without first obtaining the lender's permission, the lender can call the loan immediately due and payable. This provision, found in most loan documents, is known as the "due on sale clause."
ASSUMABLE LOANS Veterans Administration guaranteed loans that originated before March 1988 and FHA loans originated before
On the seller’s side, FHA and VA sellers lost a large number of potential buyers when FHA and VA restricted assumption of their loans. First, many of the older, fully assumable, loans have been refinanced to take advantage of lower rates. Those that remain have low balances requiring the buyer to put down a large down payment. Most buyers can not or would prefer not to make such a large down payment. Second, many sellers do not have sufficient equity to contribute toward the buyer's new-loan closing costs. These sellers are looking for a cheaper way to finance the sale. Third, many homes won't appraise at a high enough value to pay off the seller's old loan and costs of sale.
On the buyer's side, lenders have tightened qualifications for new loans and many buyers are caught in today's credit crunch. Investor loans are almost non-existent. Other buyers may be capable of paying the loan but are never given a chance because they don't fit a lender's profile. One hard-to-finance group is the credit challenged including newly employed persons, immigrants, the self-employed and those with recent job changes.
THE VA CONTRACT FOR DEED There are many high balance, low interest VA loans on the books. Investors, credit impaired or credit challenged buyers should consider using a Contract for Deed on a restricted assumption VA loan. VA regulations allow and encourage this practice, making the so-called non-assumable VA loan, assumable without qualification. Furthermore, the lender can not change the interest rate or charge a processing fee or the normal VA funding fee equal to one-half percent of the loan balance.
To quote from the regulations, "When a borrower sells on an installment contract, contract for deed, or similar arrangement in which title is not transferred from the seller to the buyer, this is not considered a 'disposition' and ... therefore does not require approval by VA or the loan holder prior to the execution of such an agreement."
THE NON-VA CONTRACT FOR DEED The large number of sellers with high-balance, low-rate loans has led to a new interest in conventional and FHA Contracts for Deed. The Contract for Deed violates the due-on-sale clause and leaves the buyer and seller open to the possibility the lender may discover the transaction and call the loan. If this happens, and the buyer can not qualify for a new loan, foreclosure may result. Nevertheless, there are a large number of buyers and sellers willing to take this chance. While no one can guarantee the lender will not call the loan, it has been shown that lender's do not seem to care -- so long as the buyer keeps the payments current. There is little financial incentive for the lender to call the loan because interest rates have remained low. In fact, calling the loan only invites trouble for the lender - better to avoid yet another foreclosure.
Are these arrangements illegal? No, violating the due-on-sale clause is not against the law, or criminal. It is a breach of a covenant in the loan documents and entitles the lender to call the loan, if they choose to do so. That is all it does.
Buyers and sellers interested in Contracts for Deed need to understand the risk. If the lender discovers the transaction and decides to call the loan, the buyer must immediately refinance. If the buyer is unable to do so, foreclosure may result. While the chance of a lender invoking the due-on-sale clause may be slight, the loss, should the lender decide to demand payment, could be substantial.
WHAT IS A CONTRACT FOR DEED? The Contract for Deed is a method of private financing whereby the seller retains title to the property until the buyer has paid the purchase price in full. It is similar to buying on lay-away except the buyer takes possession of the property and enjoys the benefits of ownership, including all income tax deductions for interest and property taxes. Qualifying is as easy as the seller wants it to be. Costs are less because there are no lender processing fees, VA funding fees or points.
HOW DOES IT WORK? At settlement, the seller executes a Deed to the buyer. The buyer pays any down payment and closing costs and executes a Note payable to the seller. The buyer takes possession of the property. Both parties execute the Contract for Deed and related escrow agreements
So far, the transaction looks like a regular settlement. The difference is: instead of recording the Deed, the attorney records the Contract for Deed at the
For non-VA Contracts for Deed the attorney may record a Mortgage or Performance Deed of Trust against the seller's interest in the property. This Mortgage or Deed of Trust secures the buyer's interest in the property and prevents creditors of the seller from asserting an interest ahead of the buyer.
The settlement attorney holds the Deed and Note in escrow pending payoff of the loan when the buyer sells the property or refinances. Then, the attorney records the Deed vesting full title in the buyer. The seller signed all necessary documents at the first closing. It does not matter if he later moves from the area, dies or is otherwise unavailable.
The buyer makes a monthly payment to the seller or a third party and the buyer's payments pay the existing loan. This is sometimes called a sales agreement or a wrap-around contract because the second loan "wraps around" or includes the first. If the seller does not want to collect and pay the monthly payments, the buyer can send them directly to the lender or third party. In either case, the parties should keep in touch with the lender to be sure the payments are made on time.
WRAP AROUND LOANS Wrap around loans have several interesting features. The parties can agree on a loan term different from the existing loan. For example, the seller may want his VA eligibility returned in five years and could make the wrap-around due then.
In addition, the seller can realize a profit on the new financing by charging the buyer a higher interest rate than he pays on the existing financing. For example, if the existing loan is $100,000 at 5%, the seller pays $5,000 per year in interest. If he charges the buyer 6%, he receives $6,000 for a $1,000 profit each year. This is an incentive for the seller to accept a lower selling price, thus reducing the cash down payment. The combination of low down payment and financing without formal application makes the Contract for Deed very attractive to buyers.
HOMEOWNER'S INSURANCE Homeowner's (sometimes called hazard) Insurance serves several purposes. It insures the real property (structure) against fire, storm damage and other losses. It may also insure personal property (furnishings) against these perils and additional risks such as burglary. It may insure the owner against personal injury lawsuits. A landlord policy can also cover loss of rents while the property is restored after a casualty such as fire.
Lenders always require insurance to cover the structure for at least the loan amount or guaranteeing to replace the structure. For condominiums, the condominium association provides this insurance and the cost is included in the condominium fee. The condominium buyer will only need insurance to cover personal property and liability and can ignore the balance of this discussion of insurance.
In Contract for Deed transactions, there are three interests to protect: the lender, seller and buyer. The seller remains the legal titled owner of the property. The buyer has a contractual interest in the property. All these interests are insurable and must be insured. The seller would expect the policy to insure at least the total amount of all financing or replacement cost. The buyer will want a policy including personal property and other coverage as desired (sewer back up, earthquake, jewelry, guns, furs, etc.). The following general guidelines assist buyers and sellers in meeting their insurance needs. Please discuss your particular needs with your insurance agent.
MULTIPLE INSUREDS One method of insuring both the seller and buyer is to list both as named-insureds on one policy. With a VA loan, the buyer can be the primary insured and the seller added as secondary. With a non-VA loan, the seller would remain as the primary insured with the buyer listed as an additional insured in the mortgagee clause. All policies must name the lender as a secured party. Some insurance companies may have membership or other restrictions that will not allow use of multiple insureds.
MULTIPLE POLICIES Some insurance companies will treat the property as non-owner occupied because the title owner (seller) does not live there. They amend the policy to the equivalent of a landlord policy covering the structure and the seller's personal liability only. The buyer then needs a Contents (Renter's) policy covering personal property and his personal liability if they intend to live there. This method is more expensive as it requires two policies.
After settlement, insurance on the structure is included in the monthly payment and future annual insurance bills may go to the lender for payment. If multiple policies are used, the buyer will pay for contents coverage separately each year.
You may have to apply to more than one insurance agent or company before finding one willing to accept all parties. Make all your insurance arrangements before settlement. Take a copy of the policy to settlement.
ADVANTAGES FOR THE SELLER No appraisal, lower closing costs, wider range of potential buyers, and quicker settlement (no waiting for lender approval).
RISK TO THE SELLER The Contract for Deed contains risk for the seller. In all cases, the seller remains liable on the loan until it is paid or an approved assumption completed. Veterans should keep the VA and the lender informed of their forwarding address. To protect the seller, many Contracts for Deed provide that upon default, the buyer's interest terminates and all sums previously paid are rent. Then, the seller can evict the buyer and take the property back.
This risk of non-payment is similar to the risk assumed by any landlord. The contract for deed has an advantage over a lease because the buyer is paying the full cost of the mortgage, homeowner fees and maintenance. In addition, the buyer has paid closing costs and has a ownership interest.
ADVANTAGES FOR THE BUYER No loan qualifying, low down payment, favorable interest rates, lower closing costs, quicker settlement (no waiting for lender approval).
RISK TO THE BUYER The buyer risks paying an inflated price because the sellers offer favorable financing. Since there is no lender appraisal, the buyer may wish to order one himself and make the contract contingent. Even with a fair price, if the contract requires payoff in a relatively short time, there may not be enough appreciation to cover costs of sale. Three to five years is a minimum recommended time for a refinance.
If the Contract for Deed terminates the buyer's interest upon default, and treats all payments as rent, the buyer could stand to lose his investment.
For a non-VA loan, a lender who discovers the transaction may call the loan immediately due and payable. If the buyer can't find financing, foreclosure may result and the buyer could lose the benefit of his investment.
COSTS TO CLOSE The total closing costs are less than a new loan or qualifying assumption because there are no lender fees, no VA Funding Fee, no recording fees for a Deed of Trust and a survey is not required. Expect to pay additional attorney fees of depending upon the complexity of the case. The parties usually choose to split this. Other closing costs including settlement, title insurance and recording fees usually remain the same as a regular closing. Settlement can occur rather quickly because there is no loan application processed. It usually only takes a week for a title search and to obtain loan and escrow balance information.