Coming out of the Great Recession, Congress and the Consumer Financial Protection Bureau (“CFPB”) created safeguards to protect borrowers from predatory loans or loans that they could not afford to repay. With a few exceptions, these new laws governed all loans to purchase a primary residence. The laws required lenders to make certain disclosures and to assess the buyer’s ability to repay the loan. Many states, including Washington, increased the protections for borrowers who have defaulted on loans by slowing down the foreclosure process when a borrower defaults on a home loan.
These protections are not present in a few types of loans, one of which is a sale where the seller acts as the lender. In Washington, most seller financed sales are done with a typical note and deed of trust type of mortgage. In this case, the seller signs a deed to transfer the property to the buyer and the buyer allows a loan (promissory note) to be secured against the property by recording a deed of trust. Another way to complete a seller financed sale is by a “real estate contract” (also known as “land contracts,” “installment land contracts” or “contract for deed”). The abbreviation for a real estate contract is REK 1. With a REK, the buyer gets most of the property rights at the time the REK is recorded. Most importantly, they get the right of possession, but they also have a right/duty to maintain the property, insure the property and treat the property as if they are the owner. Upon fully paying the seller-financed loan, the seller records a “fulfillment deed.” This deed transfers the last, but very important, property right of actual legal title.
The difference between a typical sale with seller financing (deed, promissory note and deed of trust) and a REK is that the seller technically remains the owner until the loan is paid and has a different process of foreclosing on the loan if it becomes in default. With a REK, the process that a seller/lender would follow if the buyer/borrower defaulted on the loan is called a forfeiture. A forfeiture is faster and has less protections than a typical deed of trust foreclosure. The biggest difference is that the property reverts (is forfeited) back to the seller/lender after the proper notices are recorded and notice is given to the borrower. Any equity in the property is also forfeited to the seller/lender. In Washington State, the legislature has created a process that a borrower can demand a sale instead of a forfeiture, but it requires that the borrower know about the options and have the resources to make it happen. The CFPB is concerned that many buyers on a REK either do not have protections like we have in state law, or do not now about those protections and the equity that they have in the property (remodeling, down payment and market appreciation) will be lost if a forfeiture happens.
The CFPB is also concerned about a few other legal issues that can come up in REKs, but would not come up with a typical deed sale.
No Appraisal. Because owner financing does not involve an institutional lender, the regular lending practices, like requiring an appraisal, are not present. An appraisal is primarily meant to protect a lender from lending more than the property is worth, but it also serves a purpose in showing a buyer what the value of the property is, which can avoid a buyer overpaying for a property.
No Title Search Performed. There may be states that no title search is forearmed with a REK sale, but in Washington, these are treated like a normal sale, and a title search is part of the typical process. I guess any property could be sold by any method without a title search, but a sale by a REK does not make that risk any greater than a typical deed sale in Washington.
Interest Rate and Other Disclosures. A seller is not required to make the same inquiry as a mortgage lender when they are lending money to a buyer in a seller financed sale. The Washington Department of Financial Institutions requires a minimum disclosure to the buyer and to the DFI, but the disclosures are nothing like the detailed disclosures a typical mortgage lender is required to make. Any buyer that is obtaining seller financing has additional risk of misunderstanding the loan terms, but this risk is not unique to REK transactions.
Second Mortgages. Because a buyer in a REK does not have legal title to the property, it is likely that they will not be able to get a second mortgage or home equity line of credit. These tools are often necessary for homeowners to make repairs or investments in their home. Without the ability to use the equity in your home, an owner may be more likely to default on the mortgage.
Timeline of Forfeiture. After a borrower defaults on the loan, a forfeiture is over 100 days faster than a foreclosure of a deed of trust.
Surplus Proceeds. In a deed of trust foreclosure, the surplus proceeds become available for the borrower to get. This is not the case in a forfeiture, unless the borrower sues the lender to force a sale instead of forfeiting the property, together with all of the borrower’s equity.
Eviction of Borrowers. In Washington a lender cannot evict a borrower before following the forfeiture statute, but in other states, a lender can quickly terminate the occupancy and recover the property. This concern is present in sales that are made as “lease-to-own” or with a “Lease with option to purchase.” While these are similar to REK sales, they present more risk to a buyer and need to be carefully drafted to meet the specific needs of buyer and sellers.
Discrimination. REKs are often used for properties that cannot be used to obtain normal loans or for borrowers who cannot obtain normal loans. For this reason, REKs are often marketed to people who believe they cannot buy a house, whether it is because they cannot afford one or because they cannot qualify for a loan. The CFPB has found that these types of sales have targeted minority communities, poor communities and specific religious groups. Washington State limits seller financed sales to situations where the home was the seller’s actual home. A person could not buy hundreds of homes and then sell each one as seller financed in Washington.
Many of the concerns that the CFPB discusses in their August 2024 article titled Report on Contract for Deed Lending 2 are mitigated by protections and regular practices in Washington State law. The NWMLS has a form for real estate brokers to use in seller financed transactions, and that form can be used for either REK or deed of trust loans. However, some of the risks the CFPB identified are still present in these transactions in Washington, such as 1) without appraisals, a buyer is more likely to overpay for a property, 2) without detailed loan disclosures, a buyer is more likely to default because they cannot afford the payments on the loan, and 3) because a forfeiture is a faster process and does not pay the surplus equity to the borrower, it is more likely that the equity someone has built in their home may go to the lender in a forfeiture. Many of these risks are present in any seller financed sale, but because Washington only allows a limited number of sales that a person can do in a year and in their lifetime, the possibility that an investor could use this process to take advantage of thousands of people is not as much of an issue in Washington State. If the CFPB is going to regulate this type of sale, they should look at the guardrails that Washington State has put up to protect buyers. Our state laws insulate buyers in Washington from the worst issues with REKs that the CFPB is concerned with.
- Don’t ask me why the abbreviation for contract is “K,” but if you are curious, a law student wrote an article in the Minnesota law Review in 2022 on that topic. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3919584
- https://files.consumerfinance.gov/f/documents/cfpb_contract-for-deed_report_2024-08.pdf