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Deann Gayles refused to let her marred credit history stop her from realizing her dream of buying a house.
The St. Paul resident knew she wouldn't qualify for a traditional mortgage in such a tight credit market, so she sought an alternative form of financing that is gaining popularity throughout the Twin Cities: a contract for deed.
Also known as a land contract and an installment sale agreement, a contract for deed is an arrangement where the seller provides the financing for the buyer.
Through a program offered through Dayton's Bluff Neighborhood Housing Services, Gayles was able to buy a tidy four-bedroom, multilevel house. She's already busy painting and making improvements.
"They led me the right way," she said of the St. Paul nonprofit.
Gayles and her husband, Steven, were able to finance the $149,900 St. Paul home at a rate of 7 percent for 30 years. She plans to refinance in three years.
Contracts for deeds have nearly doubled between 2004 and 2010 to 1,200. Experts say the actual number is likely three times higher because most contracts are informal and are never recorded.
But with that rapid growth has come an increasing amount of complaints about the terms of such deals. While a popular last resort for house hunters who can't get financed otherwise, contracts for deeds are largely unregulated and are ripe for abuse.
Some housing advocates warn that these arrangements have now taken the place of the mortgage scams that contributed to the fall of the housing market six years ago.
"At this moment it's the most prevalent form of predatory lending," said Kristin Siegesmund, head of the consumer unit at Legal Aid Society of Minneapolis.
Seller financing isn't new. Contracts for deeds were popular in the 1980s when interest rates were in the double digits. Many sellers would use contracts with a lower rate as a way to entice buyers. Siegesmund herself bought a house on a contract in the mid-'80s when the mortgage rate was 16 percent.
"The concept in and of itself is not bad," she said. "The problem is that a lot of people on both sides of the equation don't understand what they are."
Complaints about contracts for deeds have swelled, said Luke Grundman, an attorney for the Legal Aid Society of Minneapolis.
The most common problems are associated with terms that favor sellers, including high interest rates and short repayment terms.
Typically, a contract for deed is offered by a seller who doesn't have a mortgage on the property. The sales price is paid in installments. Often, the interest rate is a couple of percentage points higher than market rate and the term is usually five to seven years, which requires the buyer to refinance or make a large balloon payment when the contract expires. Once all the payments have been made, the owner gives the buyer the deed to the property
Some sellers tout the low cost of executing a contract because an appraisal isn't required, but that's risky because a buyer could agree to pay more than the house is worth, making an eventual refinancing impossible.
One of the most troublesome forms of abuse, Grundman said, is when seller financing is used as a way to avoid complying with rental licensing laws. In Minneapolis, there have been property owners who've owned fixer-uppers that couldn't pass a rental license inspection, so they "sold" the property using a contract for deed, which requires no property inspection.
And in many ways, buyers have less protection than they would with a signed rental agreement. If the buyer misses a payment, the property owner often has the right to cancel the contract and evict the buyer quickly.
Efforts to regulate contracts for deeds in Minnesota have been largely unsuccessful. In 2009, a bill that would have provided disclosures and protections for contracts for deeds died in committee. A similar measure has been introduced this session, according to Ron Elwood, supervising attorney for the Legal Services Advocacy Project.
Several housing groups recently published "The Contract For Deed Guidebook," which gives pointers to help protect buyers and sellers alike.
"There is still room for a lot of mischief, and it's important for the buyer to beware," said Warren Hanson, president of the Greater Minnesota Housing Fund, one of the groups that helped produce the guide.
The Greater Metropolitan Housing Corp. has also gotten involved by offering contracts for deeds through its SHOP Home Mortgage program on rehabbed houses that it sells to people who might not otherwise qualify for bank financing. It requires them to attend homeownership courses and credit counseling before they buy.
The program is partnering with Dayton's Bluff Neighborhood Housing Services, the program Gayles used to buy her home. Already, 40 homeowners have successfully financed houses through the nonprofit. The program has been so successful, the group is trying to raise more money to expand the program. Gary Beatty, vice president of SHOP Home Mortgage, sees it a way to help stabilize neighborhoods that have been ravaged by the foreclosure crisis.
"This also benefits the community because it puts another family in the house," Beatty said.
Jim Buchta • 612-673-7376