Mortgages, contract for deeds, lease options…what do they all mean? These are the three types of mortgage notes (or paper) you will run into as a note investor.
Let’s delve…
Mortgages
Most people are familiar with a mortgage. The mortgage is the instrument (or the piece of paper) that ties the promissory note to the deed. Many people say they are “paying their mortgage,” but they are really satisfying the promissory note. Once they satisfy that note after paying a certain principal and interest for a period of time (usually 30 years), they own the property.
Mortgages are considered more secure because the borrower owns the property while they are paying off their mortgage (or the promissory note). The borrower is responsible for insuring the property, caring for the property, handling the maintenance and anything else associated with that property. Should they default, the bank can then foreclose and take the property back.
Contract For Deed (Land Contract)
A contract for deed (also known as a land contract, depending on what state you are operating in), is different from a mortgage because the borrower doesn’t own the property until he/she satisfies the contract or pays off the promissory note. In other words, the borrower satisfies the contract and then the lender will hand over the deed (hence the term, contract for deed).
The borrower is still responsible for the maintenance and upkeep of the property and should get full insurance coverage; however, the lender is still the owner of the property. Documentation can be filed with the county/city recorder showing that there is a contract for deed in place; however, that does not shift ownership. The lender will remain the owner until the borrower satisfies the contract.
Lease Options
Many people avoid lease options because they don’t understand them or they have had bad experiences with them. The lease option is a rent-to-own situation. Generally, the contract is for seven or less years and the borrower is paying “rent” to the lender. A portion of the payments are taken out as credits to purchase the property within the seven or so years. The lender owns the home and is giving the borrower a chance to clean up their credit or save enough for a down payment to purchase the home.
The borrower is responsible for the maintenance and upkeep of the property and can get homeowners or renters insurance. The benefit of lease options is that there are great returns. The lender is getting paid for up to 7 years and then can offer seller financing to the borrower and continue to receive payments for another 10, 20 or 25 years.
The downside to lease options is that sometimes the borrower doesn’t exercise their right to buy the property and they exit, leaving you with a vacant property. That’s not a true downside because you can put a new borrower in the property without touching the property (no new paint, carpet or renovations involved), and still continue to make a profit off of the asset.
Conclusion
Depending on your investing strategy, you may choose to invest only in mortgages or you may choose to invest in all three types of paper. Whatever you are comfortable with, just be sure to do your due diligence and make sure the numbers work to meet your investing goals.
