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With the sharp increase in the number of bankruptcies and foreclosures, a growing number of consumers with poor credit are choosing alternate methods to finance a new home. The most popular way of going around the traditional lender is with a contract for deed. Contract for deed arrangements have been around for a long time. Most of the time, they refer to a direct transaction entered into between the buyer and seller to purchase the home.
Advantages of Alternate Home Financing
- No Credit Check: The primary reason buyers enter into a contract for deed arrangement is they do not need to have to be approved based on credit score to purchase the home. The deal is between the buyer and seller, so there is no bank involved and no one to turn you down because of bad credit.
- Nearly 100% Financing: In most cases, a purchase can be made with a contract for deed with little to no down payment. Since there is no bank involved, there are no closing costs either. Some sellers may want 1% or 2% down or a little more, but typically, the buyer does not need to come up with as much as with a traditional mortgage.
- No Appraisal Needed: Because the finance company is not involved, there is no need to do an appraisal on the property for the agreement to be approved. Essentially, the only two parties that need to agree to the terms of the deal are the buyer and the seller.
Disadvantages of Alternate Home Financing
- Higher Interest Rate: Because the buyer usually has poor credit, they will likely pay a significantly higher interest rate than through a mortgage lender. For example, if the current rate for a 30 year fixed mortgage is running at 4.5%, the rate on a contract for deed will typically be in the 6%-7% range.
- Fewer Home Purchase Options: The vast majority of home sellers are not interested in acting as the finance company after the property is sold. For this reason, there are relatively few homes on the market with the option for a direct buyer/seller agreement. In addition, as it becomes more of a seller’s market, this will become increasingly the case.
- Less Security after Move-In: Contracts for deed do not need the approval of a lender or government regulator. Essentially, all that is happening is the buyer is sending monthly payments to the seller and the seller is paying the mortgage. However, what if the seller falls on financial hard times and, unbeknownst to the buyer, stops making the mortgage payments? Eventually, that could lead to a home foreclosure and the buyer losing the house, even if they are faithfully making their payments.
For those with less than perfect credit, it can be tempting to enter into a contract for deed arrangement in order to more quickly get back into home ownership. However, the risks associated with such arrangements make this a far less secure purchase. In most cases, it is best to talk with a mortgage broker about ways you can improve your credit faster, so you can qualify sooner for a conventional home mortgage.