NEW YORK – The pandemic housing market has been especially tough for homebuyers looking at the lower end of the price spectrum.

In June, homes sold under $100,000 fell by 27% compared with a year before, where homes sold between $750,000 and $1 million went up by 6%, according to data from the National Association of Realtors.

Apart from a dearth of starter home construction, financing has been a major barrier. In 2019, only 23% of homes priced below $100,000 were purchased with a mortgage, compared with 74% of homes priced at or above $100,000, according to the Urban Institute.

Lenders shy away from small mortgages because of high fixed origination and servicing costs, regardless of the loan size, say experts.

The shortage is leading millions of prospective homeowners to turn to alternative arrangements to finance their home purchases. One of the most common forms of alternative home financing, land contracts – also known as “contracts-for-deed” or “installment sales contracts” – can be particularly predatory, say consumer watchdogs.

What is a land contract?

Land installment contracts, also known as “contracts for deed,” are seller-financed home sales in which a homebuyer makes regular payments to the seller over a period of 30 or 40 years, but the deed does not transfer until the last payment is made. A single missed payment can be a cause for eviction.

Buyers who use land contracts are typically households who couldn’t qualify for a conventional mortgage or couldn’t pass a credit check to get into a conventional rental property.

Is it a new way of financing?

Land contracts are not new. Many working-class Black families in the 1950s and ‘60s were forced to turn to speculative sellers after the federal government refused to insure mortgages in redlined minority neighborhoods.

Speculators often bought homes at a discount from white families as they fled racially changing neighborhoods to sell them months later to Black families at inflated prices and high interest.

Since the Great Recession, however, land contracts have made a comeback, with large investment companies having bought up foreclosed properties from Fannie Mae. And a high percentage of these properties are in Black neighborhoods, according to a paper by the Federal Reserve Bank of Atlanta.

Are land contracts a potential path toward homeownership?

Proponents of land contracts say these arrangements provide a viable means for low-income and credit-challenged families to access homeownership, especially when they can’t obtain a traditional mortgage loan from a bank or other financial institution.

For sellers, a contract for deed instead of a mortgage could be attractive since they can charge higher interest, a belief that the transaction can be completed without a lawyer and, in the case of a buyer default, they can skip foreclosure and go through a forfeiture, which is fast, easy and inexpensive.

What are the downsides?

From the buyer’s perspective, purchasing a property on land contract combines the worst of buying and renting, say experts. It is marketed disproportionately to low-income families of color as an alternative path to homeownership, but instead allows investors to avoid responsibility for property upkeep while churning successive would-be homeowners through a property they could not legally rent, says Sarah Bolling Mancini, a staff attorney at the National Consumer Law Center.

Eric Seymour, an assistant professor at the Bloustein School of Planning and Public Policy at Rutgers, has focused his research on contract sellers, both the big actors such as Harbor Portfolio as well as smaller “slumlord speculators.”

Seymour says land contracts are particularly attractive for unscrupulous property dealers looking to make money because rather than offering them as a rental – which ostensibly puts the property owner on the hook for property maintenance and repairs – a land contract gives all the responsibilities to the buyer, he says.

“The down payment on these properties could be as much or more than what these investors paid for these properties in the first place,” he says.

Mancini agrees.

“Sellers profit by churning a house through one land contract buyer after another. Sellers take whatever down payment the would-be owner can afford, pull in their payments and sweat equity for as long as possible, and then evict them and cycle another buyer into the property,” Mancini writes in her National Consumer Law Center report, “Toxic Transactions: How Land Installment Contracts Once Again Threaten Communities of Color.”

What are the risks?

The transactions are typically invisible in the public deed records, which puts contract buyers at risk of having their interest jeopardized by a later transfer or encumbrance, and also puts the reliability of the public land records and ability to convey good title into question, according to research by Pew Charitable Trusts.

Land contracts generally include a forfeiture remedy that can deprive contract buyers of all of their investment in the home and any equitable interest in the home. In many states, the law requires little or no legal process or public auction of the home for the highest and best value.

Are land contracts recorded?

The terms of a contract for deed may vary, as do particular state and local laws and protections.

Only about a dozen states require that land contracts be publicly recorded, an important provision that protects all parties involved by clearly and legally documenting the buyer’s homeownership, according to research by the Pew Charitable Trusts. Only one state, Virginia, mandates that homes purchased with land contracts meet specific standards for habitability.

What are some recommendations?

The National Consumer Law Center has made the following recommendations to the Consumer Financial Protection Bureau (CFPB) for rules it could consider to govern land contracts:

• An appraisal to establish the actual value of the property
• An inspection to establish the true condition of the property
• Assurances that the property taxes are paid
• Fair application of the payments made by the buyer
• Prohibition against contractual clauses which cost buyers their hard-earned investments in the property when there is an early termination.

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