Selling or Buying Real Property? Seller Financing is Still a Valid Tool
By Mark D. Shipman
SAALFELD GRIGGS PC
With interest rates at historic lows and credit constrained, some real estate buyers and sellers are forced to consider alternative forms of financing. Seller financing is still a valid tool for buyers and sellers to use in securing obligations and promises in the buying and selling of real property. Two commonly used instruments to secure the sale of property are land sale contracts and promissory notes with trust deeds. This article is intended to briefly highlight these two financing instruments, discuss some benefits and pitfalls of seller financing, and briefly overview the remedies that can be pursued under both instruments.
LAND SALE CONTRACTS
Essentially, a land sale contract involves a contract between a seller and a buyer where the seller is financing the purchase instead of a bank. The buyer agrees to make regular payments; the seller retains the title to the property and, upon full payment of the purchase price, will convey the title to the buyer. The land sale contract typically consists of a single document that contains standard contract provisions and specific provisions agreed upon by the parties for that particular property sale. In addition to the contract form there are two additional documents that are generally used – a memorandum of contract and a deed. A land sale transaction can include a memorandum of contract which gives notice that the property has been sold, but keeps the terms of the sale private. The final document is a deed. Whether that is a statutory warranty deed or a bargain and sale deed can depend on the parties’ preferences and facts surrounding the seller’s ownership of the property. The deed is not recorded until the contract is paid in full. Instead it can be held in escrow with joint instructions, signed by both parties, that upon payment of the contract the escrow company is to record the deed.
A trust deed is an instrument between the seller as “beneficiary” and the buyer as “grantor” in which the seller finances the purchase instead of a bank. The buyer agrees to make regular payments to seller as the beneficiary. Unlike with land sale contracts, with trust deeds there is an unrelated third party that serves as the trustee. This party is normally a title company.
In addition, a promissory note is used in conjunction with a trust deed. The promissory note is used as a promise from the buyer to pay the seller the loaned amount on certain terms at certain times. Similar to the land sale contract, trust deeds and promissory notes can come in all shapes and sizes. They can include standard provisions based on the location of the property and specific provisions inserted based on the unique aspects of the particular transaction (e.g., a requirement that the buyer paint the house every five years). The trust deed can be recorded in whole or a memorandum of trust deed can be used if the parties determine they don’t want the entire trust deed to be of record. Finally, a deed is recorded evidencing the buyer’s ownership of the property.
BENEFITS OF SELLER FINANCING
- May allow a buyer to obtain real estate even if they would not be able to obtain financing through the normal loan process.
- May allow a buyer to build credit and equity.
- Works best if seller has no prior security instrument (trust deed, mortgage, or land sale contract) on the property.
- Under a land sale contract, the seller remains on title. Under a trust deed and promissory note, the buyer obtains title.
PITFALLS OF SELLER FINANCING
- More risk to both the buyer and the seller.
- If the seller has an existing trust deed, or is buying on contract from someone else, the assignment/ assumption of that prior contract/note is not guaranteed.
- Most contracts and trust deeds have “due on sale” clauses that are triggered when the seller attempts to sell their property on contract or on a trust deed when there is a prior recorded land sale contract, mortgage, or trust deed on the property. This can put both parties at risk, particularly in this lending environment.
- If the seller stops paying on their prior contract or trust deed, the buyer is at risk, or if the seller breaches the prior contract or trust deed (i.e., files for bankruptcy or violates the law) the buyer is at risk.
- If the parties are not represented by an attorney, they could be missing important provisions and safeguards for the buyer and the seller.
- If the parties do not use a title company for closing/escrow they could be at risk for future sales if no title insurance policy is issued. Also, if they are not represented by a realtor or an attorney they could be missing important provisions and safeguards.
Remedies under land sale contracts and trust deeds are different. For example, land sale contracts generally contain provisions for such remedies as statutory forfeiture, strict foreclosure, or specific performance. Remedies under trust deeds generally involve foreclosure.
There is a statutory right of forfeiture under the land sale contract. In theory, this can be “quicker” than a non-judicial foreclosure. However there is a catch. The Oregon statutory forfeiture and time to cure provisions are governed by how much equity the buyer has in the property:
- If buyer has > 75% of debt in relation to value of the property, the buyer has 60 days within which to become current on the contract;
- If buyer has > 50% but < 75% of debt in relation to value, then the buyer has 90 days;
- If buyer has < 50% of debt in relation to value, then the buyer has 120 days.
The two most common remedies under trust deeds involve either judicial or non-judicial foreclosure. Judicial foreclosure enables the beneficiary (seller) to clear the property of inferior interests in the event of questionable or competing claims or liens. If there are no third party claims, liens or other creditors, non-judicial foreclosure is a quicker method to gain possession and ownership of the property if needed.
Picking which instrument to use in a seller financed real estate transaction depends on a number of factors. Often time there is no “perfect” instrument but, regardless of whether you use a land sale contract or a trust deed, the instrument needs to be crafted to fit the specifics of your transaction. If you are contemplating using seller financing, contacting one of the firm’s Real Estate and Land Use attorneys and setting up a meeting to discuss your goals can ultimately save you money and result in a more secure transaction.