How long have contracts for deed existed, and why is the Federal Reserve studying them?
As appeared in the Cleveland Fed Digest's Ask the Expert on 11.26.2019
Contracts for deed, through which a homebuyer borrows from and makes payments to the seller of real estate rather than to a lender, were prevalent in the 1960s and 70s in Chicago’s black communities. This was a time when most blacks couldn’t get access to traditional mortgage credit. Redlining, or the labeling by banks of specific areas as “undesirable” for lending, led bankers to withhold credit in those areas, leaving contracts for deed the only option for many buyers of color in neighborhoods where property values were depressed.
Contract for deed buyers have all of the responsibilities of home ownership—for example, they pay property taxes and insurance—but none of the protections. Unlike traditional mortgage holders, contract buyers do not get the deed to their houses until they pay off the contracts, and they don’t build equity in the homes. Missing one payment can result in the seller’s taking back the property, often with no recourse, even if the buyer has been paying on the contract for years. If this happens, any investments the buyer made in the home are lost.
Although contracts for deed have been around for some time, the activity has gained renewed attention since the Great Recession. Researchers and media outlets such as the New York Times began examining the activity of large corporate sellers of contracts for deed. Often these large sellers purchased properties in bulk at very low prices and sold them via contracts for deed, usually at inflated prices and frequently with property liens and delinquent taxes attached.
When my colleagues and I learned about a national database on contracts for deed, we decided to take a broader look at this activity. Our research examines contract for deed activity across six Midwestern states and covers urban and rural places and larger and smaller sellers of contracts for deed. We find that contracts for deed tend to be more concentrated in places with lower incomes, higher shares of blacks, higher rates of housing vacancies, older housing stock, and lower homeownership rates. In addition, the houses people seek to own through contracts for deed tend to be of lower value than other houses, values at which traditional mortgage credit is limited or nonexistent.
There is a need for alternative lending products that can provide safe mortgages for people who are purchasing properties at lower values.
While contracts for deed may be a viable option for those buyers with limited credit history and no down payment and for those seeking to purchase lower-value properties, the near lack of consumer protections for contract buyers is a concern. Consumer law specialists point to the need for laws that protect contract buyers, including ensuring that homes are habitable before being sold, conducting an independent home inspection to confirm habitability, and ensuring the ability of a buyer who’s missed a payment to catch up on their payments.
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Lisa Nelson is community development research manager, overseeing the research of the Cleveland Fed’s Community Development Department. The department conducts research on three core topics: workforce and economic development, housing and access to credit, and small business.
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