Contracts for Deed -- Legal but Unadvisable!

A contract for deed is an agreement for the sale of real property from a seller to a buyer which is financed by the seller. The buyer takes possession of the property upon signing the contract for deed. Contracts for deed are often referred to as "rent to own" financing arrangements, and are legal in Texas. However, they are not preferred. Under this arrangement, the buyer will make payments to the seller in monthly installments under the terms of the contract for deed. If and when the buyer completes the payments (often after several years of payments) then the seller conveys the property to the buyer by a warranty deed. A contract for deed is often used by developers to sell housing to lower income families in lieu of traditional seller-financed transactions (Warranty Deed, Real Estate Lien Note, and Deed of Trust).

One of the most important differences between a contract for deed and a conventional purchase contract is that under the "contract for deed" the buyer generally does not gain immediate equity in the property as he makes payments. Under a contract for deed arrangement, the buyer only has an equity interest after they have paid 40% of the loan or more, or have made 48 monthly payments. That means that any default made before this time results in the Seller simply classifying those payments as "rent."

As a matter of Texas law, contracts for deed are considered executory contracts, not security devices. In Texas, it is widely held that until the purchase price is paid in full the Buyer under a contract for deed has only an “equitable right” to complete the contract, not equitable title to the property. See Johnson v. Wood, 157 S.W.2d 146 (Tex. Comm’n App. 1941, opinion adopted). The reasoning in Johnson has reflected the law in Texas for over 60 years and has been followed by numerous courts. See Clinton Park Dev. v. Commissioner, 209 F.2d 951 (5th Cir. 1954); Gaona v. Gonzales, 997 S.W.2d 784 (Tex. App.—Austin 1999, no pet.); Club Corp. of Am. v. Concerned Prop. Owners, 881 S.W.2d 620 (Tex. App.—Beaumont 1994, writ denied); Texas Am. Bank/Levelland v. Resendez, 706 S.W.2d 343 (Tex. App.—Houston 1986, no writ); Guzman v. Acuna, 653 S.W.2d 315 (Tex. App—San Antonio 1983, writ dism’d w.o.j.); Neeley v. Intercity Mgmt. Corp., 623 S.W.2d 942 (Tex. App.—Houston 1981, no writ); Jensen v. Bryson, 614 S.W.2d 930 (Tex. Civ. App.—Amarillo 1981, no writ); Bradford v. Cole, 570 S.W.2d 171 (Tex. Civ. App.—Texarkana 1978, writ dism’d w.o.j.). Indeed, not long after statehood the Texas Supreme Court distinguished between the equitable right that a Buyer receives ab initio under a contract for deed and the equitable title he receives when the purchase price is paid in full. See Browning v. Estes, 3 Tex. 462 (1848); Hemming v. Zimmerschitte, 4 Tex. 159 (1849).

Contracts for deed can also have strict conditions. Some consumers with a contract for deed have lost their homes because they were a few days late on one payment. This meant that despite making timely payments for years, the contract forced them to leave the property with no stake in the investment. It is therefore critically important for a Buyer to know exactly what type of real estate purchase and financing contract they are signing!

The abuses related to "Contract for Deed" financing mechanisms were laregely abated by House Bill 1823, which became effective on September 1, 2005. This legislation greatly expanded the Texas law governing contracts for deed to apply to home leases that contain purchase options. More specifically, House Bill 1823 amended section 5.062 of the texas Property Code to include the following language, which applies to application of "Contract for Deed" laws:

"[A]n option to purchase real property that includes or is combined or executed concurrently with a residential lease agreement, together with the lease, is considered an executory contract for conveyance of real property."

This means that any lease of residential property accompanied by an option to purchase the property, constitutes a single Contract for Deed transaction (lease and option agreement together = contract for deed).

In addition, HB 1823 required Sellers to provide a large array of services, disclosures and safeguards designed to protect Buyers under a contract for deed. This legislation, which is now incorporated into the Texas Property Code, has made it burdensome and periolous to for sellers to use a "contract for deed" in owner-financed transactions.

Nevertheless, if you are entering into a real estate purchase or sale, you should contact an experienced attorney to provide you with guidance and advice concerning the best legal way to accomplish your sale. Trey Wilson is a licensed attorney and real estate agent, who is experienced in drafting, interpreting and explaining real estate sale and purchase documents. Contact attorney Trey Wilson at (210) 223-4100 or rlw3d@sa-law.com