Is an obscure method of financing inexpensive houses postcrisis a liability? Or is it a viable alternative for people who would otherwise be shut out of homeownership?
It's a bit of both, according to new research by the Federal Reserve Bank of Atlanta.
Not surprisingly, investors have found ways to profit from each phase of the boom-bust-gradual recovery in the housing cycle. The Great Recession flooded housing markets with millions of foreclosed properties. Lenders that repossessed houses, including the government-sponsored mortgage enterprises, often sold these properties very cheaply. With so many houses available at rock-bottom prices, some investors bought in bulk with an eye toward earning returns by renting or selling.
One method of selling—or not quite selling—foreclosed homes apparently spread in the South and Midwest after the housing crash; it is called a contract for deed, or land contract. Ann Carpenter, senior community and economic development adviser at the Federal Reserve Bank of Atlanta, recently cowrote a discussion paper examining these transactions. Coauthors were Abram Lueders, a former Atlanta Fed intern and staff planner for the Downtown Memphis Commission, and Chris Thayer, a Fed intern and graduate student in public policy and city and regional planning at Georgia Tech.
Basically, a contract for deed requires buyers to pay monthly installments on homes they receive as is. In some cases, interest rates are many times higher than prevailing mortgage rates. The buyer is responsible for bringing the home, which is often in disrepair, up to habitable standards within a few months. Failure to repair the house, or missing a single monthly payment, means the lender takes back the home. The buyer in these transactions builds no equity in the home and does not receive the deed until the last payment is made, often 20 or more years after the agreement is struck.
Used responsibly, such alternative financing methods offer a much-needed pathway to homeownership, points out the paper.
Nonprofit organizations, for example, have offered contract for deed financing to help prospective buyers who can't qualify for a traditional mortgage. Nonprofits continue to use contracts for deed in neighborhood stabilization and asset building strategies. In some cases, distrust of the traditional financial system also leads people to this unconventional route, especially since the foreclosure crisis. These arrangements offer a path to ownership for low-income people who otherwise would have almost no chance to buy a home, Carpenter points out.
However, contract for deed sales also have been abused. In some cases, unsophisticated borrowers with little access to legal or financial assistance have become entangled in financing schemes that charge high interest rates and include unforgiving forfeiture clauses.
At their worst, Carpenter explains, contract for deed sales trap low-income buyers in unfavorable arrangements that are difficult to escape without losing the home they are seeking to acquire. These situations can cause housing instability, destabilize communities, and block low-income families from accumulating wealth. Consequently, contract for deed sales can worsen an already widening divide in U.S. property ownership, because a home is a major source of wealth for middle- and lower-class Americans, she adds. For example, Dallas Fed researchers identified contracts for deed as an obstacle to wealth building in the Texas Colonias, a string of impoverished Mexican-American communities near the border.
Asset accumulation already appears tough for minorities. Over the past 30 years, the average wealth of a white family in the United States has grown 84 percent, compared to just 27 percent for African American households, according to a 2016 study by the Institute for Policy Studies and the Corporation for Enterprise Development, research centers that focus on economic opportunity. Racial disparities in homeownership, those researchers found, are a major cause of that wealth gap, Carpenter and her coauthors write.
Atlanta Fed CED informs policymakers
As part of its mission, the Atlanta Fed's Community and Economic Development (CED) unit gathers evidence to shape policies that promote sustainable affordable housing for low- and moderate-income populations.
"Our work on contract for deed sales is mainly intended to raise awareness of the issues surrounding this practice and to inform policy discussions and recommendations," Carpenter says. "There are still many unanswered questions in the data, but I think it's safe to say more consumer education and protections can help address some of the issues we have uncovered."
These protections include basic practices like requiring that contracts be recorded within a certain number of days, an independent inspection and appraisal be conducted, and all taxes and liens on a property be resolved before it is sold.
Carpenter and her coauthors find that corporate contract for deed sales increased from 2008 to 2013 (see chart) but have since plateaued or declined in four major southeastern cities. Corporate investment pools frequently bought foreclosed properties in bulk from Fannie Mae, which disposed of hundreds of thousands of foreclosures in the wake of the housing crisis. Those mass auctions ended a few years ago.
Foreclosures were particularly acute in majority African American neighborhoods. That left large pools of properties available in those areas. Consequently, most corporate-owned contract for deed houses are in majority African American neighborhoods. For example, in the Atlanta metropolitan area in 2013, the apparent peak of corporate contract for deed activity, 64 percent of properties owned by known contract for deed sellers were in majority African American census block groups, according to the Atlanta Fed CED discussion paper. The numbers were even higher for Birmingham (71 percent); Jackson, Mississippi (94 percent); and Jacksonville, Florida (66 percent).
Carpenter calls the concentration in minority neighborhoods "very troubling," as the abusive practices of some landlord-sellers help perpetuate racial and class gaps in wealth. Though the unfavorable arrangements by corporate investors have received considerable attention, the paper finds that a larger number of contracts for deed involve small-scale sellers such as private individuals or local firms. The terms of contracts vary, with roughly equal numbers of seemingly low-risk contracts and contracts with extremely high interest rates and unforgiving forfeiture clauses.
Data on contract for deed sales are incomplete. Many states don't require the transactions to be recorded with local governments, unlike traditional real estate sales. And even in states that require recording, laws are unevenly enforced, Carpenter and other researchers have found. Moreover, the U.S. Census Bureau American Housing Survey in 2009 stopped collecting national data on homes purchased with land contracts. Still, the older census survey data suggest that about 5 percent of all mortgage holders actually have a contract for deed, Carpenter says.
A path to homeownership, but an unstable one
"This is an informal but often unstable path to home ownership," Carpenter says of contract for deed sales.
The apparent surge in the transactions post-housing crash fits an unfortunate sequence that has bedeviled low-income home buyers in recent years: first subprime lending created widespread misery, then the foreclosure crisis happened, and then contract for deed sales became more common. "It's a repeating cycle where people left behind are at risk of getting further and further behind," Carpenter says.
Contract for deed sales are not new. A 2009 book by the historian Beryl Satter, Family Properties: Race, Real Estate, and the Exploitation of Black Urban America, chronicles the struggles of African Americans caught in onerous contract for deed arrangements in Chicago in the 1950s through the 1970s. In the mid-20th century, Carpenter notes, contracts for deed were common in response to bank redlining, the practice of refusing to make loans in minority neighborhoods.
Carpenter plans to extend this research. Along with colleagues at the Cleveland and Chicago Feds, she aims to examine contract for deed activity in midwestern states that require public recording of contracts.