Can you explain the distinction between a Contract for Sale and a Purchase Contract? Stumped already? Then you should read this article! You should know what these documents are and the differences between them. It’s not difficult. Not only that, you will sound smart and feel good if you can knowledgeably discuss these documents. So, read on.
First, let’s answer the question. A Purchase Contract is like the document real estate agents use every day. For residential property virtually every Realtor® agent uses the Arizona Association of Realtors Residential Resale Real Estate Purchase Agreement. New home sellers generally have their own custom contracts as do commercial agents. It is the basic document buyers and sellers use to agree upon the terms of purchase of real estate. A Contract for Sale accomplishes the same purpose as a Purchase Contract, with the exception that the seller carries back a portion of the selling price. When recorded a Contract for Sale creates a lien upon the title of the property. So a Cont5ract for Sale does double duty – it is a both a purchase contract and also is a security document. So why don’t we use the Contract for Sale more? You will see if you read on.
You know what a “mortgage” is – right? It is a legal document that provides the lender of money a secured position in real property. If the borrower does not pay the obligation (usually memorialized in a promissory note) due the lender, then the lender (mortgagee) can foreclose on the borrower (mortgagor). In other words the mortgage secures the promise to repay normally contained in the promissory note which the borrower has agreed to pay. The promise to pay (in the promissory note) is then further “secured” by the recording of the Mortgage on the borrower’s real property. Deeds of Trusts and Contracts for Sale do exactly the same thing as a mortgage. They are all “security” documents. They memorialize the pledge of real property to guarantee that the borrower performs the promise to pay the lender. If the borrower does not pay the lender the lender can “take” the borrower’s real property which was pledged as security. Naturally the lender hopes that if there is a default in payments by the borrower that the real property pledged as security is worth enough to pay the balance due on the obligation due the lender. Are you with me so far?
As you can see the security documents we are discussing all do the same exact thing. They protect the lender by giving the lender a lien or security in the borrower’s real estate. Yes, they are the same in that they provide the lender security if there is a default in the lender’s obligation to repay the lender. However, the similarities end there. They have substantial differences. So let’s examine the differences among the three security documents and attempt to determine why and when you would prefer one over the other.
The major distinction among the three documents is how efficiently the lender can get his/her security in the event of a breach of the promises of the borrower. If the lender uses a mortgage and there is a default the lender must use a judicial foreclosure to get the security. A judicial foreclosure means that the lender has to file a lawsuit in Superior Court alleging the default. The borrower can object and file and answer and the matter can be tied up in court for a significant period of time. Following the end of the lawsuit, assuming the lender is successful; the borrower has six months to redeem the property by bringing all the payments current together with a ten percent (10%) penalty. So the property could be unavailable to the lender for perhaps eighteen (18) months to two (2) years. That is not attractive to most lenders. However, it used to be the primary security document that lender used until the later 1960s. Then it tied for use with Contracts for Sale. Then Deeds of Trust became popular for reasons we will discuss. Contracts for Sale and especially Deeds of Trust provided speedier ways for the lender to obtain the security. The distinction in the way the lender can obtain the real estate which is the security for the loan affects the decision of the lender as to what security document is best to use. Knowing those differences will assist you in choosing the best security document to use for a given transaction.
FORECLOSURES WITH MORTGAGES
A judicial foreclosure is the most cumbersome and probably the most costly method to use. As noted, it involves a lawsuit. That is the primary reason hardly anyone uses a Mortgage as the security document anymore. While the terms “foreclosure” is the most widely used term for getting property back to the lender, it is the least utilized process for doing so. The term “foreclosure” is not generally used to generically getting the secured property into the hands of the lender in the event of default by the borrower. It does not necessarily mean that the lender used a mortgage. So, if it takes a long time to foreclose a Mortgage and it is expense why would anyone consider using a Mortgage? The answer is that once the foreclosure is filed then the debtor must pay the lender the entire loan balance or lose the property. Often the borrower doesn’t have sufficient case to pay off the entire balance and may not have the credit to refinance so the lender will most likely lose the property. If the borrower has some equity in the property over and above the loan balance a mortgagor may assess the situation and determine it may be better to accelerate the entire balance due the lender causing the borrower to lose the property and the lender may end up with a property worth more than the loan.
TRUSTEE SALE WITH DEEDS OF TRUST
If the lender elects to secure the obligation due him or her with a deed of trust then the lender can pursue a foreclosure process (more appropriately referred to as trustee’s sale) without a lawsuit. The process involves giving the borrowed a ninety (90) day notice during which specific notices must be mailed, posted and published, giving interested parties notice of the proceeding. During that time the borrower can cure the deficiency by paying the past due amounts owned, plus certain allowable costs up to 5:00 PM of the day before the sale of the secured property is scheduled to occur. If the borrower can pay up the deficient amount (not the entire unpaid principal balance like with a Mortgage) the borrower’s position is reinstated and the trustee’s sale will be cancelled. So, while non-judicial foreclosures are much quicker and less expensive than judicial foreclosures, they permit debtors to continually fall behind in their payments, curing their defaults each time that a trustee’s sale is commenced. However, since additional costs and attorney fees get added to the reinstatement it acts as a deterrent to borrowers letting the loan get into default too many times. It becomes too costly. Today, probably ninety nine percent (99%) of all loan transaction on real estate are done with Deeds of Trust.
FORFEITURES WITH CONTRACTS FOR SALE
If the lender utilizes a Contract for Sale he/she has the option to foreclose like with a mortgage (see above) or affect forfeiture so long as the account is placed with a servicing agent (like at an escrow company which services loans). The remedy for a default by the borrower is known as a forfeiture action. Forfeiture actions involve providing specific notices to all parties who show an interest in the real property according to the public records. The time period for completion of a forfeiture action can take anywhere from thirty (30) days to one hundred and eighty (180) days, depending on how much of the purchase price has been paid as of the date of the default. Thus depending on how much of the loan the borrower has paid off, the time for the borrower can be very short or very long. If the lender is skittish about the borrower and is afraid (s)he may default right up front it would be good reason to consider using a Contract for Sale. If the borrower defaults after a considerable time then it will take much longer for the lender to get the property back. In the interim the borrower can pay up the deficiency and continue with the Contract for Sale.
Unlike Mortgages and Deeds of Trust, with Contracts for Sale, title does not pass to the purchaser until all amounts owed have been paid in full. There is often confusion associated with this fact. People believe they like the Contract for Sale since, unlike with Mortgages and Deeds of Trust, when the loan is being made at the time of acquisition of the real property, title does not pass to the buyer until the entire obligation is paid in full. That is a mere technicality today and it does not have any particular benefit. Today the Contract for Sale is only a security document just like a Mortgage or deed of Trust. With a Contract for Sale the agreement of the lender and borrower are spelled out in the security document whereas with a Deed of Trust and Mortgage there is a promissory note separate from the security document.
The other area of confusion is that those unfamiliar with Contract for Sale often confuse the terminology of a Contract for Sale versus a purchase contract. As noted above a purchase contract is just that – it is used to memorialize the terms of agreement between a buyer and seller whereas the Contract for Sale can include both the element of being a purchase agreement as well as a security document all in one document.
So now you know all about the similarities and differences in Mortgages, Deeds of Trust and Contracts for Sale. Now that you know all about these security documents you can see that it is not that difficult to understand the similarities and differences.