In an era of tight credit markets, and with many individuals seeking to purchase a home or other property following a foreclosure or bankruptcy, financing a real estate acquisition – be it single family residential, multi-family or commercial – requires more effort and creativity than in the recent past. With banks reluctant to lend money to persons or for projects deemed “risky”, buyers and sellers wanting to close a deal have had to resort to two tried and true methods of alternative financing; namely, contracts for deed and rent to own arrangements.
Contracts for Deed
A contract for deed is, simply put, the seller financed acquisition of real estate. Instead of a bank loaning the money to the buyer to pay the seller in full at a closing, the seller agrees to accept some amount of a down payment (to be negotiated between the parties) and periodic (usually monthly) installments of principal and interest for an agreed upon duration of time. Many contracts for deed cover a shorter period of time than the typical, thirty year fixed rate mortgage, with a balloon payment due at the end of the contract term. At the end of the contract term, if all payments are made, the seller (also known as the contract “vendor”) delivers a deed to the buyer (the contract “vendee”), which deed conveys fee title to the subject property to the buyer.
If a buyer and seller desire to enter into such a contract, it is highly recommended that they use the uniform statutory form contract for deed as well as the uniform statutory addendum which contains several key provisions not addressed in the main contract (such as acceleration of the contract balance upon a default and whether the contract is a recourse or non-recourse obligation). Furthermore, using an attorney to assist on the transaction is imperative due to the many legal requirements surrounding contracts for deed. Once signed, the contract for deed must be recorded with the county recording office.
The buyer on a contract for deed is said to own “equitable title” to the subject property. Hence, in the event that the buyer defaults on the payment obligations under the contract for deed, the seller must follow a cancellation process set forth in Minnesota Statutes Section 559.21. This statute requires a sixty (60) day written notice of cancellation be served upon the buyer. If the buyer objects to the grounds for cancellation, the buyer can proceed with a court action and an injunction to stop the cancellation from becoming effective. If the buyer takes no action, the contract is cancelled, the seller may retain any payments previously received by the buyer, and equitable title to the property reverts to the seller.
Rent to Own
In a “rent to own” arrangement, the parties enter into a lease agreement for the property, together with an option to purchase agreement (alternatively, the parties can include purchase option provisions within the lease agreement itself). Under this structure, the landlord retains all title to the property and the tenant pays monthly rent for a specified term. If the tenant remains current on his/her obligations under the lease agreement, the tenant has the right to purchase the property upon the conditions set forth within the option to purchase agreement (or the option provisions of the lease).
It is important to note that, when entering into a lease with an option to purchase, Minnesota courts do not enforce “agreements to agree.” Hence, it is vitally important that the parties agree to all material terms of the purchase at the time the lease is entered into in order to avoid future uncertainty. In fact, it is highly recommended that the parties agree on the form of the purchase agreement to be used in the event the tenant exercises the option to purchase, and to attach that form to the lease or option to purchase agreement, as applicable.
Under Minnesota law, an option to purchase must be supported by valuable consideration (meaning that the party receiving the option must pay something to the party granting the option). While the facts and circumstances are the driving force behind determining what is a reasonable option price, it is a good practice to require payment of at least $1,000.00 from the tenant/optionee to the landlord/optionor.
Due On Sale Clause
In determining which is the most appropriate deal structure, key factors are whether the property being sold is subject to a mortgage and, if so, does the mortgage contain a "due on sale clause". A due on sale clause is a provision in a mortgage which provides that the borrower may not transfer title to the mortgaged property without the mortgage lender's express written consent. If the borrower does in fact transfer title without such consent, such a transfer is considered a default in the mortgage which allows the lender to declare the entire loan balance due immediately.
Due on sale clauses have relevance when considering a contract for deed sale because the the transfer of "equitable title" to the buyer/vendee as referenced above is sufficient to trigger the due on sale clause. Hence, a contract for deed sale involving a property subject to a mortgage usually requires the mortgage lender's written consent, and such consent is not typically forthcoming. A rent to own transaction, by contrast, does not involve a transfer of title and thus no such consent is required. Note, however, that the seller may still have issues with the lender if he/she represented that the property would be owner-occupied and is no longer as a consequence of the rent-to-own transaction.
Contracts for deed and rent to own arrangements are both attractive alternative financing arrangements for facilitating real estate sales in today’s marketplace. However, it is imperative to consult with a real estate attorney in order to properly structure these transactions and avoid legal problems at a later date.