Real Estate Contracts

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Real Estate Contracts, also know as Land Contracts or Installment Land Contracts are often appealing to both buyers and sellers. For the seller, he can move his property with little or no oversight from lenders or appraisers and sell to someone with less than perfect credit. For the buyer, he sees the opportunity to purchase without qualifying at a bank and without paying all those exorbitant closing costs. But buyer and seller beware...these instruments are not all they're cracked up to be and should generally be avoided by both parties.

The problems with the contracts are many. But in general, problems arise because these documents are heavily slanted to favor the seller and thus frequently end up in costly legal battles. One of the perceived advantages to the seller is quick and easy foreclosure in the event of a default. But try to enforce this provision on a buyer…at a minimum you will usually have to start an eviction process to get the buyer to move out. And typically a buyer will rush to an attorney who will wrap you up in a lengthy and expensive battle in court with an uncertain outcome. And all the while, you have to pay your attorney and perhaps make payments to a senior lien holder with no income coming from your buyer.

Here in New Mexico, these real estate contracts are still fairly common. But in recent years the courts have exercised their oversight to somewhat level the playing field in favor of buyers. In the "good old days" a real estate contract with a hair-trigger foreclosure provision would be enforced immediately and without question. Not any more. If the buyer's equity is fairly large compared to value, the court may determine that a confiscation of this equity by the seller "shocks the conscience of the court" and thus will not allow it without intervention. This means a judicial foreclosure process would be required.

One method that is used to expedite or otherwise attempt to circumvent the judicial process is to have the buyer execute a deed from the buyer to the seller. This deed is then held unrecorded by an escrow agent. In the event of a default, the escrow agent is instructed to record the deed or return it to the seller for recording. As a lender, I have used this technique on private loans in New Mexico and Illinois but fortunately, have never had to try to implement it's provision. And there is a cloud of uncertainty because state law may determine that it is unenforceable. For example, in Colorado such a deed held in escrow has been judged to be a mortgage and requires a judicial court process in order to foreclose. So if challenged, there may be no advantage to using this technique.

Another common reason for using real estate contracts is to avoid the ever-present "due-on-sale" clause. This is especially a consideration when using the wraparound mortgage, which is essentially a real estate contract. Since title doesn't transfer until the loan is paid off, the senior lender is kept in the dark…so the theory goes. While indeed this may work, technically a sale did occur and the lender may accelerate the loan. If this were to happen, who is responsible for getting a refinance loan? And from the perspective of the buyer, what if the seller fails to make the senior loan payments?

In a recent New Mexico case, a buyer purchased a mobile home park on a real estate contract. Over a number of years following purchase the buyers made timely payments but failed to adequately maintain the property. Finally, they stopped making payments to the sellers, who promptly folded up their escrow account, recorded their deed and repossessed the trailer park. A court battle ensued and ultimately the sellers prevailed. The buyers lost their equity, lost ownership interest in the property and were required to pay over $16,000 for the seller's attorney fees. In their decision, the court held the buyer's lack of adequate maintenance and failure to make back payments was sufficient cause to allow the forfeiture.

Sometimes you win and sometimes you lose. And that's the point. Real estate contracts are fraught with risk for both sellers and buyers. As an entrepreneur, you really need to think through the pro's and con's before entering into such a contract from either side of the transaction. In most cases, you are probably better off using the standard note and mortgage or deed of trust instrument.

By Kevin C. Myers.

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