Effective Sept. 1, 2001, new rules govern both existing and newly executed contracts for deed, which place greater burdens on residential lenders and brokers. Failure to comply with the new provisions subjects sellers who finance residential loans, lenders and brokers to a Deceptive Trade Practices Act (DTPA) violation and in some cases as much as $500 per day in damages.
Owners or lenders can finance the sale of real estate and retain a security interest two ways. The most common is a real estate lien note secured by a deed of trust. The other is a promissory note secured by a contract for deed. Both methods have advantages and disadvantages for lenders and buyers.
Buyers prefer the deed of trust. At closing, the buyer receives both title and possession of the property. If a default occurs, the lender may foreclose under strict statutory guidelines to divest the buyer of both title and possession. If the foreclosure sale generates a surplus, the excess goes to the buyer.
In the past, lenders preferred the contract for deed, sometimes referred to as a contract of sale or an executory contract for conveyance, which was used frequently with seller financing. At closing, the buyer took possession but not title to the property. The seller retained title until all or part of the promissory note was paid. If the buyer defaulted, the lender accelerated the promissory note, terminated the contract, regained possession and retained all payments made by the buyer. Nothing resembling a foreclosure sale, in which excess proceeds go to the buyer, took place.
By making changes to the Texas Property Code (TPC), Texas legislators came to the aid of buyers who purchase a home using a contract for deed. For this reason, after Sept. 1, 2001, lenders, sellers and brokers may prefer deeds of trust over contracts for deed. However, lenders and sellers should be aware that the law changes the rules for existing contracts for deed, too.
The new rules apply only to transactions using a contract for deed to purchase residential property (lots of one acre or less are presumed to be residential). Not covered are land sales by the State of Texas, by the Texas Veteran's Land Board or transactions in which the deed is delivered within 180 days. The rules apply to sales between closely related individuals as long as the buyer does not waive the statutory requirements in writing.
The language requirement under the new law for contracts negotiated on or after Sept. 1, 2001, may prove formidable for some sellers and brokers. The law states, "If the negotiations that precede the execution of an executory contract are conducted primarily in a language other than English, the seller (or broker) shall provide a copy in that language of all written documents relating to the transaction . . ." This means that precontractual notices, the contracts and all post-contractual notices, et cetera may need to be drafted in Spanish, Vietnamese, Chinese, Hindi, Arabic, Korean or other languages.
The new rules burden the seller (or broker) with many precontractual disclosures and documentations not required under deeds of trust. These notices apply to contracts negotiated and some contracts entered on or after Sept. 1, 2001. Noncompliance subjects the seller and possibly the broker to a private or public DTPA violation and allows the purchaser to cancel and rescind the contract. A rescission entitles the buyer to a full refund of all payments made pursuant to the contract. The seller or broker must provide the buyer with the following disclosures under the contract for deed.
In addition to precontractual disclosures, the statute describes three provisions that must be included in the contract for deed. Again, these requirements apply to contracts on which negotiations began on or after Sept. 1, 2001.
The notice, placed near the purchaser's signature, must contain the following language: "YOU, THE PURCHASER, MAY CANCEL THIS CONTRACT AT ANY TIME DURING THE NEXT TWO WEEKS. THE DEADLINE FOR CANCELING THE CONTRACT IS (DATE). THE ATTACHED NOTICE OF CANCELLATION EXPLAINS THIS RIGHT." The buyer may cancel the contract by signing and sending the notice to the seller by telegram, certified or registered mail or personal delivery.
THE NEW LAW, if negotiations are conducted primarily in a
language other than English, all documents must be drafted in that
Just as certain items must be placed in the contracts, the statute limits or prohibits the inclusion of others. For example, if late payment fees are included in the contract, they may not exceed the lesser of 8 percent of the monthly payment or the actual administrative cost of processing the late payment.
Likewise, the contract cannot prohibit the purchaser from pledging the buyer's interest as security for utility improvements or fire protection improvements. For contracts entered before Sept. 1, 2001, the purchaser could pledge the property only to obtain a loan to improve the property or to improve the safety of the property. Finally, the contract may not impose prepayment penalties or any similar fee if the buyer elects to pay the entire amount before the maturity date.
After the contract is signed, the law imposes four more requirements on the seller during the term of the contract.
The law defines a default under a contract for deed as the failure to make a timely payment or a failure to comply with terms of the contract. Placement of a lien on the property for utility service does not constitute a default. The new law dictates what the lender may do in the event of a default. The following provisions apply to all contracts for deed on which a default occurs on or after Sept. 1, 2001.
On default, the buyer no longer automatically forfeits all prior payments. The seller's remedies depend on whether the buyer has tendered 40 percent or the equivalent of 48 monthly payments. If less than 40 percent has been paid, the seller must send a notice by registered or certified mail, return receipt requested, to the purchaser's residence or place of business. The notice must be written in conspicuous 14-point boldface type or in 14-point uppercase typed letters that includes on a separate page the following statement:
YOU ARE NOT COMPLYING WITH THE TERMS OF THE CONTRACT TO BUY YOUR PROPERTY. UNLESS YOU TAKE THE ACTION SPECIFIED IN THIS NOTICE BY (DATE), THE SELLER HAS THE RIGHT TO TAKE POSSESSION OF YOUR PROPERTY.
The notice must:
After receiving the notice, the buyer has 60 days to pay the amount in default or to remedy the breach of the contract specified in the notice. If the buyer does not comply within the 60-day period, the seller may either rescind the contract by returning all the payments made by the buyer or accelerate the note and cause a forfeiture of all the buyer's prior payments. Nothing similar to a foreclosure sale occurs. The seller selects which remedy to pursue in the default notice.
If more than 40 percent has been paid, the seller has only one option: to appoint a trustee to sell the property. However, the notice of default is not the same. The seller must send a 60-day notice worded as follows:
YOU ARE NOT COMPLYING WITH THE TERMS OF THE CONTRACT TO BUY YOUR PROPERTY. UNLESS YOU TAKE THE ACTION SPECIFIED IN THIS NOTICE BY (DATE), A TRUSTEE DESIGNATED BY THE SELLER HAS THE RIGHT TO SELL YOUR PROPERTY AT A PUBLIC AUCTION.
The statute requires all notices to be written and sent in the language in which the negotiations were conducted.
The procedure for conducting the sale must comply with Section 51.002 of the TPC, the same law that governs foreclosure sales under deeds of trust. Among other things, the trustee must post, file and serve notice of the sale in the county where the property is located at least 21 days before the sale is conducted. The sale is conducted on the first Tuesday of the month after the 21-day period. For more information on foreclosure procedure see A Homeowner's Rights Under Foreclosure (technical report No. 825).
At the sale, the trustee conveys title to the purchaser and warrants that the property is free from encumbrance. Any proceeds that exceed the debt go to the buyer-in-default. Unless the contract for deed states otherwise, the purchaser-in-default is subject to the same collection procedures specified in Sections 51.003–51.005 of the TPC for any deficiencies resulting from the sale.
Sellers and lenders are required to convey legal title to the buyer and record the deed within 30 days after receiving the final payment. This requirement applies to all contracts. However, the following penalties apply only to contracts entered on or after Sept. 1, 2001. For these contracts, a violation entitles the buyer to $250 per day starting on the 31st day and continuing until the 90th day. After that, daily damages rise to $500 until compliance occurs. The purchaser is entitled to reasonable attorney's fees needed to collect the damages and to secure title to the property. The daily penalties are suspended in instances in which title is being adjudicated following the seller's death.
Sellers or lenders who have used and who contemplate using contracts for deed to finance residential sales face tougher rules. The precontractual, contractual and postcontractual requirements are extensive and penalties for breaching them are severe. Buyers no longer forfeit past payments automatically on default. For these reasons, sellers and lenders may wish to use deeds of trust instead of contracts for deeds for financing sales of residential property.
Fambrough (email@example.com) is a member of the State Bar of Texas and a lawyer with the Real Estate Center at Texas A&M University.
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