Have you heard people talk about selling a house to a buyer who doesn’t have to go out and get a mortgage? Do you know what it means to sell a house on contract? This is a common phrase that is used by real estate investors and others. It has a legal meaning, but in this article we are discussing the common use of the term and also what it could mean for you as a home seller. Nothing in this article is legal advice of course, but simply some information to help you along the path to obtain legal advice if you ever choose to do so.
When the owner of a home decides to sell it, and also decides to serve in the capacity of the lender, that is often referred to as “selling on contract.” In other words, the buyer does not have to go out and find a lender in order to get a mortgage to buy the home. The present owner of the home, especially if that owner has no mortgage on it at all, extends credit to the buyer and accepts monthly payments on the home, just as a mortgage lender does. In a manner of speaking, the homeowner is the lender as well as the seller.
If this sounds a bit confusing, just hang on and keep reading. It will soon be clear to you what it means to sell a house on contract. Let’s start with a typical sales or purchase agreement, such as the ones used by local associations of Realtors, or bar association forms that attorneys use. Up near the top of the first page will appear the names of the parties to the transaction, meaning the buyer and the seller. Following that important information will be the street address of the house and the legal description. Those items nearly always appear at the top of any legal form, as well as the date on which the form is drafted, or when it is going to be signed.
The next thing that generally appears on a purchase or sale agreement between a buyer and seller is the terms of financing. There are several options, of course, and many forms actually have boxes that can be checked in order to save time filling out a more complex description by hand or computer. One of the boxes will pertain to a cash transaction where the buyer pays cash for the house and has no outstanding mortgage balance on it. Another option will be “subject to financing,” which means the buyer is applying for a mortgage of a certain amount, with mortgage approval on or before a specified date. And finally, another option is the one we are describing in this article about how to sell a house on contract.
The choice to sell a house on contract is not as common as cash sales and sales that are subject to financing. There’s a simple reason for this, of course, and that reason is money. Most sellers want or need to sell a home in order to get the money to buy another home, or to get money for another purpose. The majority of sellers are not interested in selling on contract and accepting monthly payments from their buyers because that means they will not get all their equity at closing. They will get it over a period of time, usually at least ten years, up to thirty years. Thirty year mortgages are very common in the commercial mortgage market, but homes sold on contract usually have shorter periods, such as ten, fifteen or twenty-year payoffs.
Mortgage companies are institutions that can function with mortgage notes that are outstanding for long periods of time because loaning money on homes is their primary business. But individuals, even real estate investors are not institutions and they do not have a desire to wait thirty years to collect their money. Although a home mortgage or a contract sale can often serve as an excellent investment for homeowners looking for a decent interest rate on their money (as opposed to the very low interest rates currently offered on bank accounts and certificates of deposit) the fact is that interest is dependent on the time factor. A mortgage company that loans out $100,000 over a period of thirty years may profit in the amount of two to three times as much in interest as the money it originally loaned. This is a good example of the time value of money.
The biggest decision you will face if you are contemplating the prospect of being the lender when you sell a house on contract is whether or not to secure your sale with a note and mortgage. This is a legal issue that should be explored with a local attorney. Once again, this article is not written as legal advice or a description of how contract sales of real estate work in any particular area, but here is one point to consider: The legal ramifications of selling on contract with or without a note and mortgage to secure the sale transaction may be expensive and time-consuming if you have to evict your buyer for non-payment. Nobody likes to think about a home sale going awry, but it happens. In fact, it is not uncommon. Buyers change their minds and lose their nerve or their money, and in the meantime they simply fail to purchase a home as they have agreed to do.
If your buyer doesn’t show up at the closing table and your transaction fails to close, that is bad enough. But at least you can put your home up for sale and start over, marketing and eventually locating another buyer. However, when you sell a home on contract you are going to be vulnerable for a much longer period of time. Every month you will be receiving a payment, and at any point the payments may stop, necessitating legal action against the buyer. Making sure you have given consideration to what happens if your buyer stops making payments on a contract sale is a very important part of your transaction.
Another part is the tax ramifications to you as the seller. Make sure you contact both an attorney and an accountant so you have all the information you need to sell a house on contract successfully.