Recently, there has been an increase in attention to contract for deed financing on home purchases.
A relatively uncommon form of seller financing, a contract for deed may require a down payment and includes monthly installment payments with interest. However, the deed, and therefore legal ownership, is not transferred until the final payment is made. Contract buyers are responsible for expenses such as property taxes and insurance as well as upkeep on the home. The use of contracts for deed or land contracts by corporate entities has recently gained notice through reporting by the New York Times, Bloomberg, the Atlanta Journal-Constitution, and other publications.1The reporting revealed that several corporations formed in the wake of the foreclosure crisis acquired bank-owned properties in bulk and sold the homes using this legal but often risky instrument.
Contracts issued by corporate sellers are rife with potential pitfalls, according to various reports and my own review of legal documents. The sales values of homes may be several times the amount paid for the property and likely more than an appraisal would garner. Interest rates are well over prime – typically around 10 percent based on available documents. Buyers purchase their home “as-is” without condition disclosures from the seller or a third-party inspection, yet they are required to bring their new residence up to a “habitable” standard within a few months. Failure to complete repairs or insure the home properly or a single late payment may lead to enforcement of the contract’s controversial forfeiture clause. Essentially, the clause allows the seller to retain the property and all payments, including equity gained and the value of any improvements made. Furthermore, the seller may evict the buyer immediately.
Why would a buyer opt for such a risky option rather than a traditional mortgage? Simply put, contract for deed financing is available to low-income buyers who are less likely to be approved for a traditional mortgage, particularly in light of currently tight lending standards. Without sophisticated understanding of the financial and legal implications of the contract, it may appear to be an affordable option.
My recent paper and 2017 Atlanta Studies symposium presentation on contracts for deed, “Informal Homeownership Issues: Tracking Contract for Deed Sales in the Southeast,” provides data on recent trends in corporate contracts for deed in four metropolitan areas in the Atlanta Fed’s district (Atlanta, Birmingham, Jackson, and Jacksonville) as well as full data on all recorded contracts for Jefferson County, Alabama (the county in which Birmingham is situated). I coauthored this paper with Federal Reserve Bank of Atlanta former intern and Georgia Tech School of City and Regional Planning (SCaRP) graduate Abram Lueders and current intern and SCaRP student Chris Thayer. In the study, corporate-owned properties were identified by owner name in the tax records, beginning in 2008 through 2015. The data show that around 500 properties were owned by known corporate contract for deed sellers in all four metros in 2015, although these numbers have leveled off since peaking in 2012 and 2013.
The lack of reliable recorded contract data makes an analysis of the trend and its potential impacts difficult. However, examination of the location of corporate contract for deed properties and their concentration in predominantly African American neighborhoods is one troubling trend noted by the National Consumer Law Center (NCLC) and reinforced by our Atlanta Fed analysis of these four southeastern metros.
In Atlanta, the probability that a property owned by a corporate contract for deed seller was in a majority–African American census block group was significantly higher than random chance, based on 2013 ownership data. In the Atlanta metro area, 64 percent of properties owned by known contract for deed sellers were in majority–African American block groups. A map of corporate contract for deed properties overlaid with the percentage of African American residents in the Atlanta metro area is shown to the right. Given that informal homeownership pathways like contracts for deed are more common in lower-income and racial and ethnic minority communities2 and that the same block groups had an ample supply of foreclosures following the crisis, this pattern is not surprising, although it could have troubling consequences for household and neighborhood stability. Nationally, the majority of buyers seeking legal assistance have been African American and Latino, according to data from the NCLC report “Toxic Transactions: How Land Installment Contracts Once Again Threaten Communities of Color.” The report also notes that marketing efforts by corporate contract for deed sellers appeared to target these populations.
The paper uncovered several trends, including that corporate contract for deed sales tend to be concentrated in majority African American communities and that corporate contract for deed sellers seem to have decelerated or ceased their acquisition of foreclosed property. But many questions remain. In these southeastern metros, it is difficult to determine what percent of contracts are actually recorded and how many go unrecorded. It is therefore difficult to measure the volume of contracts and how many are high-risk versus relatively safe contracts. For example, nonprofit organizations have used alternative financing tools like contract for deed to open a pathway to homeownership and stabilize neighborhoods.
In light of what we do know about contract for deed financing, however, number of strategies have been recommended by the NCLC to better protect contract buyers. First, recordation should be required and enforced at the state level. Legal experts from the NCLC also recommend independent inspection of the home’s condition, including estimated cost of repairs, a third-party appraisal to ensure fair market value of the property, standardization of documentation, an assurance that all taxes and liens on the property are resolved prior to sale, the right to prepay without penalty, protection in case of early termination of the contract (by both buyer and seller), prohibition of abusive and unfair practices, translation of documents in the buyer’s language, strong enforcement of all policy recommendations, and greater data collection, potentially through the expansion of data collected under the Home Mortgage Disclosure Act.3
We plan to continue this research in other areas of the country where contracts tend to be recorded with greater frequency. In doing so, we hope to uncover the effects of this practice on communities and households. What are the impacts, if any, on household wealth generation and housing stability? Are there additional demographic trends that we should be concerned about? The concentration of contracts in majority African American neighborhoods is a cause for concern given the growing racial wealth divide. This research seeks to delve into the practices recently uncovered by journalists in order to provide evidence for policymakers.