What to know about buying a house on contract

Buying a house on contract — also known as using a contract for deed — is when the buyer and seller make a financing agreement instead of having the buyer take out a mortgage. Contract for deeds might be used to purchase residential property, investment property, or land.

Using a contract for deed to buy a house can provide an easier path towards homeownership, especially for people who can’t afford a down payment or have lower credit scores — but there are some disadvantages of this arrangement that you should be aware of.

Keep reading for more insight into how this type of seller financing works and more about contracts for deed agreements.

How does buying a house on contract work? 

Buying a house on contract looks a whole lot different than if you were to buy a house using a traditional mortgage, or even an all cash offer. When someone buys a house on contract, that means the seller is agreeing to finance the purchase for them. The way this works is that the seller takes on the role of the mortgage company.

After both parties agree to a sale price, the buyer will make installment payments to the seller. The seller will maintain the legal title and rights as the property owner until the buyer pays the seller back in full according to their purchase agreement. 

Typically payments for a contract for deed only last for a few years (unlike a mortgage, which is usually 30 years) and end with a larger final payment, referred to as a balloon payment. Once the payments are complete, the seller will use a deed to convey the legal title into the name of the buyer, who now owns the home.

Why would you buy a house on contract?

Potential homebuyers may consider buying a house on contract if they are unable to qualify for a loan from a bank, credit union, or other mortgage lender. The benefits of buying on contract mean:

You don’t have to put as much down

‍If someone doesn’t have a large down payment saved, buying a home on contract may work in their favor since the seller decides how much of a down payment they require, and it may not be the standard 20% that lenders prefer. (A down payment of less than 20% can lead to paying for private mortgage insurance if you take out a mortgage loan).

Your credit score matters less

‍Credit scores usually don’t carry the same amount of weight with the seller when you use a contract for deed as it does when you get a mortgage. Sellers can determine what makes a buyer “creditworthy” in their eyes, and they don’t have set standards for credit scores like mortgage lenders do. 

You can build or improve your credit

‍You can request that the seller report your on-time payments to major credit reporting bureaus each month, which can help you build a stronger credit score. (Keep in mind that they can also report any late payments, which will have the opposite effect.) 

You can pay lower fees‍

Contract deeds don’t require the same origination fees, closing costs, settlement costs, or application scrutiny that a mortgage loan does. Both the seller and buyer might save on fees with this arrangement.

What are the disadvantages of a contract for deed?

In many ways, purchasing a home with a contract for deed is a much more straightforward and efficient process than taking out a mortgage loan. That being said, there is a lot of risk associated with this type of home purchase.

‍Mortgage lenders require home inspections and appraisals before approving home loans, but these routine protocols won’t be required in a contract for deed arrangement. That means you may not be aware of any issues with the home (like structural issues or water damage) or whether you’re paying a fair price for it.  

Here are some more drawbacks to using a contract for deed:

• Interest rates can be higher: The seller gets to choose the interest rate and that means they can charge higher than the standard rates offered by mortgage lenders. It can be worthwhile to shop around for a mortgage to see what you can qualify for first.  ‍
• There may be title issues: The seller’s heirs, creditors, or the home's previous owners may have a right to the property. Without having a title company conduct a title search, which is typically required by a mortgage lender, you may unknowingly buy a property with outstanding liens or a cloud on the title when you use a contract for deed.
• You might not be getting your money's worth: Without an appraisal, you might end up overpaying for your home.‍
• You might have to pay for maintenance: Even though you won’t own the home until you make the final payment, you may be responsible for maintenance and repairs, as well as taxes and insurance, unlike in a rent-to-own contract.
• You risk default: If you miss any payments or fail to meet the terms of the contract, the seller can cancel it, and you will lose the money you paid towards the home. In some states, you can apply to have the contract for deed reinstated, but this isn’t guaranteed. ‍
• The house might foreclose: It won't matter that you consistently made your monthly payment to the seller if they don't make their own mortgage payments. The bank can foreclose on the property, putting you out of a home.‍
• You can’t access your equity: When you buy a house on contract, you won’t own the property or realize the equity until you’ve paid for it in full. That means you can’t leverage the financial contributions (monthly payments) you’ve made towards the house, like if you wanted to take out a loan against it, as you would with traditional financing.

Since the risks of buying a house on contract are steep, it’s best to only enter this type of arrangement with someone you trust, like a family member or relative who wants to sell you their home in a more obtainable way. 

How to make a contract for deed

With contract deeds, the buyer and seller work together to create a contract that works for them. It can be faster, more convenient, and less expensive to create a contract for deed than it is to take out a normal mortgage loan, which has an extensive approval and underwriting process. 

A contract for deed includes many of the same things as a traditional real estate contract, including:

Tips for buying a house on contract

If you decide to use contract for deed arrangement to buy a house, check out these tips that can help make the whole process go a lot smoother.

• Make sure the seller actually owns their home in full. If they are still paying a mortgage on the home, you’re putting yourself at great risk. If the seller fails to make their mortgage payments and the home goes into foreclosure, you can lose any rights you have to the home as well as all of the money you paid the seller. ‍
• Get an inspection and appraisal. Inspections and appraisals won’t be required in a contract for deed arrangement, but you should pursue them anyways. Inspections let the buyer know if the property needs any major maintenance or repairs. If you don't negotiate with the seller to fix these issues before you move in, you could be held responsible for the costs of the repairs.
• Have a plan for the balloon payment: Oftentimes, contract-for-deed arrangements require one large balloon payment at the end. This can be a large amount of money to save for - especially while making monthly payments to the seller - so make sure you plan ahead and budget for this large payment. If you fail to make this payment, the seller may be able to cancel the contract and you can lose all of the money you paid them. 
• Understand your rights: Read the contract carefully and gain a clear understanding of what happens if you make a late payment or can’t make the full balloon payment. Failing to make payments according to the contract can lead to you losing the home and all of the money you put towards it in monthly payments. Hiring a lawyer can come in handy. 

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