The advisory opinion is being released in conjunction with a field hearing the CFPB is holding today in St. Paul, Minnesota. Contract for deed loans have become increasingly prevalent in the Twin Cities’ Somali Muslim community. The loans are often marketed as a way for community members to abide by the principles of their faith that prohibit paying or profiting from interest.

“The CFPB has found that investors are targeting people of faith with predatory mortgage products that set the borrower up to fail,” said CFPB Director Rohit Chopra. “The government is taking action to ensure that these products do not turn the dream of homeownership into a nightmare.”

Contracts for deed – also called “land contracts,” “installment land contracts,” “land sales contracts,” or “bonds for deed” – typically cover the purchase of homes. They are structured such that the seller retains the legal title to a home until the borrower completes all the payments. During the contract term, the borrower often carries the responsibilities of homeownership, including repairs, property taxes, and improvements. In today’s report, the CFPB traces the history of contract-for-deed lending. The CFPB has found that these products often target Black, Hispanic, immigrant, and religious communities.

Many lenders using contracts for deed generally sell homes at inflated prices, with high interest rates and balloon payments. The prices can be high because sellers are not competing against banks or other mainstream mortgage lenders, and the homes come without the benefit of inspections associated with mainstream mortgage financing that identify defects in a home. Contract-for-deed sellers often also have no stake in whether borrowers can afford the loan over the long term because they can generally kick buyers out immediately if the buyers miss even a single payment, and then resell the home at an even higher price to the next family.

Many contracts for deed come laden with traps like balloon payments that make it highly unlikely the borrowers will ever get full legal title to their homes. Available data shows that contracts for deed have much higher failure rates than mainstream mortgage loans.

However, while many sellers have abused this financing structure to trick buyers and churn homes, these contracts are in fact covered by the federal Truth in Lending Act. This law imposes certain requirements on larger sellers – often investment groups – such that they must:

• Assess borrowers’ ability to repay loans: Determining a borrower’s ability to repay makes sure they can afford to repay loans, including contracts for deed. Many people who bought homes through contracts for deed – and were kicked out of their homes for missed payments – would have been protected against these predatory products had the seller assessed ability to repay.
• Provide informative and accurate disclosures: Sellers must provide the Truth in Lending Act’s required disclosures. These disclosures include the annual percentage rate and payment schedules. Predatory lenders will sometimes market contracts for deed to faith communities and lead buyers to believe that the contracts conform to religious bans on interest. However, the loans either do come with high, undisclosed interest rates or the interest rates are hidden through other means.
• Limit balloon payments: Many contracts for deed come with interest rates much higher than those commonly charged on traditional mortgages. Under the Truth in Lending Act, when an interest rate on a home loan is higher than certain published benchmarks, additional requirements and consumer protections are activated. One of those important protections is that most balloon payments are banned. Balloon payments can be especially harmful to contract-for-deed borrowers who stand to lose all the money they have previously paid if they cannot afford to pay a large lump sum all at once.

The advisory’s opinion and report are part of the CFPB’s efforts to rid the market of predatory and exclusionary home lending practices. The CFPB has taken actions to protect consumers from redlining, reverse redlining, digital redlining, predatory financing, and zombie mortgages. The CFPB also worked with federal partners to finalize rules to ensure automated valuation models do not engage in digital redlining practices.

Thank you all for joining today’s hearing.

I want to especially thank Senator Smith, Lieutenant Governor Flanagan, and Attorney General Ellison, for joining. In today’s hearing, we will hear testimony on a broad range of financial issues.

A key focus for us today is housing and mortgages. In Minnesota and across the country, families are dealing with high costs of housing. For those who don’t own a home, many are dealing with high rents that can make it harder to save for a downpayment. For those who do own a home, many feel they can’t move to a larger home or to one closer to a better job due to higher mortgage rates.

For many, there are other barriers. Some families may not have a long credit history, especially younger households and recent immigrants. Others are forced to compete with private equity and real estate investors paying cash. Still others are dealing with troubles with homeowner’s insurance and flood insurance.

The CFPB is working as part of an all-of-government effort to lower the costs of housing and reduce the barriers to homeownership.

As part of this work, we are also on the lookout for those who are seeking to turn the dream of homeownership into a nightmare. In my last visit to Minnesota, Attorney General Keith Ellison introduced me to local leaders who explained that there was a growing problem with loans targeting specific communities in the Twin Cities area. Senator Tina Smith also shared with me that there were growing problems with so-called “contract for deed” loans.

In conjunction with today’s hearing, the CFPB is announcing several actions on these loans. In addition to a report describing the contract-for-deed market, we are affirming in an advisory opinion that existing consumer protections apply to contracts for deed, issuing a nationwide consumer advisory to warn people about the potential pitfalls with these loans.

Contracts for Deed

Contracts for deed are products where a seller is also offering the source of financing outside of the mainstream mortgage system. These arrangements go by lots of names – contract for deed, bond for deed – but when pushed by predatory lenders, they are often no more than borrower traps.

Sellers – investment groups and others seeking to profit from families seeking the American Dream of homeownership – target these contracts to families who believe they are shut out of mainstream opportunities to purchase homes, and they trade on fears about the availability of affordable homes, limited housing inventory, and unfair lending.

The sellers know that first time homebuyers have been told they can’t afford a home, and offer contracts for deed as a seemingly attractive alternative. Here’s how it typically works: In a contract for deed arrangement, the seller acts as the lender. The buyer makes payments directly to the seller over time, living in the home but not owning it outright until all payments are made.

This might sound like a path to homeownership for those who feel they have no other options, but it comes with serious risks. The buyer doesn’t get the deed to the property until the contract is fully paid off, which can take decades. The principal, interest rates, and fees are often much higher than with mainstream financing. And, if the buyer misses even one payment, they could lose the house and all the money they’ve paid so far – including payments for repairs, taxes, and insurance.

While contracts for deed had previously been in decline in the Twin Cities, in recent years, the number of these loans has been increasing because sellers have been targeting specific groups, including the Somali community.¹

Contracts for deed have been marketed to the Somali Muslim community as interest-free alternatives to mainstream mortgage loans that may violate their religious beliefs. But, in reality, the marketed contracts for deed may just be mortgage loans disguised as a lease. The loans come with inflated home prices, above average interest rates, and tricks to increase the odds of foreclosure so that the seller can keep all the payments, turn around, and do it all again to another family. This home churning undermines the quality of the housing stock in neighborhoods, even as the price of the churned properties remain inflated.

Attorney General Ellison uncovered many of the tricks and traps in his recent lawsuit against a predatory lender, including hidden balloon payments, high initial payments that put the buyers immediately underwater, and inflated home prices.² Many of these players may be setting borrowers up to fail in payments they cannot afford – even though federal law is meant to stop just that.

CFPB’s Contract for Deed Research Report and Advisory Opinion

Variations of what we are seeing in the Twin Cities is happening across the United States. The CFPB published a report that explains some of the history of contracts for deed and where they can make a family worse off.

The CFPB is also issuing a formal legal interpretation to affirm that buyers are generally entitled to the protections provided for residential mortgage transactions under the Truth in Lending Act.

What this means is that the larger sellers, often investment groups, must assess a borrower’s ability to repay. They must give clear disclosures about the loan before closing, so borrowers know exactly what their payments are going to look like. And if the sellers and investment groups don’t, they can be subject to significant sanctions and borrowers can take them to court.

The CFPB is also making clear that many contracts for deed will trigger federal laws and regulations that apply to high-cost mortgages, including a restriction on many balloon payments.

Investors should also understand that splitting sales among a series of sham corporations does not allow them to evade the law.

Not only does today’s policy guidance warn lenders against ignoring their obligations under the Truth in Lending Act, but state law enforcement can point to it when they bring actions against contract-for-deed lenders under the Truth in Lending Act.

We are going to continue closely scrutinizing this market. And one of the main ways we learn about problems in the markets we supervise and about lawbreaking companies is through consumer complaints. We want to hear from homebuyers and potential borrowers about contracts for deed. Consumers are able to submit complaints about these loans – and they do. We have received multiple complaints about contract-for-deed tricks and traps. These include consumers who were lied to about whether they owned the homes, people kicked out of their homes for single payments that were missed due to hospitalizations, and higher-than-expected monthly payments.

Our actions today are just a first step, and I encourage consumers to tell us when they are victims of illegal activity.

Broader Work in the Mortgage Market

Outside of contracts for deed, the CFPB is focused on taking many other steps when it comes to housing and mortgages. We’ve taken action against tenant screening companies like TransUnion for illegal practices that harm people looking for rental housing.³

The CFPB has reinvigorated its work on redlining to rid the market of predatory and exclusionary home lending practices, including reverse redlining⁴ and digital redlining.⁵ The CFPB also finalized new rules to combat discrimination when it comes to algorithmic appraisals.⁶ And, we are working on ways to protect borrowers from payment shock when they face a cancellation on their homeowner’s insurance.

The CFPB is working to ensure that mortgage servicing is working. We have proposed rules to help homeowners avoid foreclosure, with new ways for people to work with their servicer in their preferred language.⁷ We have issued policies to address so-called zombie mortgages to block debt collectors from seeking to illegally foreclose based on a second mortgage that was already satisfied or canceled.⁸

We are also working on ways to lower closing costs which can drain a downpayment. We are working with other federal agencies on how borrowers can navigate title insurance, one of the largest items when it comes to closing costs.⁹ We are examining ways to make it easier for a seller to transfer their low-rate mortgage to a buyer. And we’re working on ways to make it easier to refinance as rates get lower.¹⁰

In closing, I want to thank everyone in the Twin Cities for joining today, and I am pleased to call this field hearing to order.

Consumers can submit complaints about financial products or services by visiting the CFPB’s website or by calling (855) 411-CFPB (2372).

Employees who believe their company has violated federal consumer financial protection laws are encouraged to send information about what they know to whistleblower@cfpb.gov.

Source: Consumer Finance Protection Bureau

Image Credit: Consumer Finance Protection Bureau