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Seller Financing The Deal

Occasionally, I still run into an old Contract For Deed for clients. In this outdated form of a transaction, the seller and purchaser enter into an agreement or contract stating that the purchaser will make payments over time and once a certain amount is paid the seller will deed the property to the purchaser. I say outdated, because in 2001 the Legislature changed the Texas Property Code regarding Contracts for Deed. This change applies to all contracts regardless of when they were entered into. To avoid common problems with this form of transaction, the law since 2001 requires the seller to disclose to the purchaser, BEFORE the contract is signed, in a written statement, the price, interest rate, total amount of principal and interest that will be paid and the amount of any late charge. In addition to this requirement, there are 11 other notices required. Suffice to say, using a contract for deed is NOT the way to convey property.

Seller financing the purchase of property is a preferred method, but must be done properly. Seller financing is a means by which the current owner of the home or land acts as the lender or bank for the purchaser. This is a common form of financing the sale of property. Some of the reasons you may want to consider Seller financing are:
1) The deal may close faster;
2) Your Buyer does not want to deal with a Third Party Lender because of the fees;
3) As a form of investment for the Seller;
4) Your Buyer does not have an extensive credit history; or
5) Perhaps your Buyer has a bad credit history.

If your Buyer approaches you about Seller financing, there are at least two things you should do to protect yourself:
1) Ask for a credit report; and
2) Ask for references.

If your potential Buyer has a bad credit history there is a reason. You must ask yourself if you want to take the risk that you may have to deal with (1) late, partial or missed payments; (2) proceeding without a substantial down payment; or (3) if the Buyer defaults having to deal with recovering your property?

Knowing a person’s credit history and how they allocate their paycheck each month will give you an idea of their priorities. When it comes to their choosing which bill to pay, you do not want to be on the short end of the stick.

Past rental references will give you an indication of the priority your potential Buyer will give to paying you. Additionally, it will give you an idea of how the potential Buyer maintains their property. If the Buyer defaults on his/her payments, you do not want to have to bear the expense of foreclosure, plus the additional cost of repairs before you can use, rent, or resell it.
The most common form of Seller financing is through the use of a Warranty Deed with Vendor’s Lien, Real Estate Lien Note, and Deed of Trust. These are the same instruments used by the lender or bank when Third Party financing is used.

By signing a Note, the Buyer is promising to pay a certain amount for the property. The note amount is listed as well as the amount of interest they will pay. Normally, the interest is negotiated just like the sales price. Because the Seller is not in the business of loaning money and is not accustomed to the risks associated with loaning money, the interest rate on Seller financed deals is usually higher than for Third Party financing.

A Deed of Trust is an instrument filed for record at the courthouse which reflects that a note has been signed for the purchase of the described real property. The Deed of Trust serves to put the public on notice that the property is being purchased by the Buyer subject to a debt being paid, and until the debt is paid, a lien exist against the property. The Deed of Trust serves as the agreement between the Seller and Buyer and sets out the conditions each party must comply with for the sale. The Deed of Trust also should provide the Seller with the right to accelerate the debt owed if the Buyer fails to make the payments as agreed. This means that if the Buyer is late in making a payment, the Seller has the right to demand the full amount of the note, after proper notice and opportunity to cure default.

The Warranty Deed with Vendor’s Lien signifies that the Buyer is the record owner of the property subject to the Seller’s lien on the property. Once the debt is paid a release of lien is filed, making the deed “absolute.” No new deed is required, because the Warranty Deed with Vendor’s Lien is the Buyer’s deed and the release of lien signifies the lien placed on the property by the Note and Deed of Trust has been paid.

Under this form of Seller financing, if the Buyer fails to perform all the requirements under the Note and Deed of Trust, then the Seller must foreclose on the property to regain it. Foreclosing on property requires filling a notice of foreclosure and providing the Buyer with a designated number of days within which to cure the default. If the Buyer cures the default and pays the cost associated with filing the foreclosure, then they retain the property and continue to make payments. If they do not, then the Seller regains the property and can sell it all over again.

If you are planning to sell some property, and are Seller financing the transaction, an important consideration is whether you are still paying on a note yourself. It is standard for the Note and Deed of Trust to provide protection to your Lienholder in the event the property is sold. This protection requires you to obtain written permission from the lender before selling the property. Failure to do so could result in the note being accelerated and the full balance becoming due immediately. There have been instances where a Seller tried to avoid this problem by not filing the Deed of Trust and Warranty Deed with Vendor’s Lien. However, these instruments have no legal effect until they are filed. Thus, if the Buyer were to default the Seller would have no legal recourse. The Seller is in a much better position if they obtain written consent from their Lienholder and insert the proper language in the Note and Deed of Trust from the new Buyer indicating the new Buyer’s note is a second lien.

Because of the legal formalities involved, you should consult an attorney when deciding to Seller finance your home or property. Seller financing the sale may allow the deal to happen faster, but you must decide if this advantage outweighs the risks and if the legal documents provide you the best protection under the law.

Sam A. Moak is an attorney with the Huntsville law firm of Moak & Moak, P.C. He is licensed to practice in all fields of law by the Supreme Court of Texas, is a Member of the State Bar College, and is a member of the Real Estate, Probate and Trust Law Section of the State Bar of Texas. www.moakandmoak.com