CD’s and Market Risk
Contracts for Deed can be a great option for home sellers with lots of equity, and Buyers who can’t otherwise qualify for a mortgage at a good rate.
Under the usual terms, the Buyer comes up with a down payment, then makes monthly payments to the Seller for a prescribed period — often 2-5 years — after which a balloon payment is due.
In theory, the Seller gets both a Buyer and a decent return on their money (vs. zero percent on their savings), while the Buyer gets a house they couldn’t otherwise swing financially.
Sellers as Bank
So, what’s the catch?
And why aren’t Realtors seeing more contracts for deed, given their advantages?
One problem is that many Sellers simply prefer a lump sum payment, rather than regular payments stretched out over years.
Another problem is the Seller’s recourse if the Buyer stops making payments — or can’t refinance when the balloon payment comes due.
Namely, the Seller gets the house keys back (but keeps the Buyer’s down payment).
Given that many Sellers with the equity to consider CD’s are older and perhaps even already retired out-of-state, the prospect of suddenly getting their home back — in what could be a lower housing market — is understandably not very appealing.
Two Risks: Market and Credit
To mitigate that risk, many Sellers properly insist on a sizable down payment.
Unfortunately, the kind of Buyer who’s the best candidate for a contract for deed typically either has blemished credit, little money in the bank for a down payment — or both.
(If it were otherwise, they would put down 20% and get a still-cheap mortgage).
In practice, then, such deals often founder because the would-be CD Buyer can’t come up with enough cash to compensate for the two risks the Seller is implicitly assuming: that the market will drop, and that the Buyer won’t perform (lenders call this second kind of risk “credit risk”).