Most American homeowners finance their homes using traditional amortized mortgages. However, millions have also used nonmortgage alternative financing arrangements, especially in places with lower-cost homes—those valued below $150,000—where access to traditional mortgages tends to be limited.
In some instances, alternative financing may provide a pathway to homeownership, but experts warn that these arrangements lack the important protections that accompany mortgages, potentially placing borrowers at risk. The available evidence indicates that many families end up sinking thousands of dollars into a home they never own, mired in legal issues, or saddled with substantial debt.
But despite recent attention from lawmakers, state agencies, attorneys general, and federal agencies and indications that alternative financing has become more prevalent since the Great Recession, the research into these arrangements is thin and reform has been slow to materialize.
The most common types of alternative financing are:
Although analyses of alternative financing contract terms and impacts on families in specific locations around the U.S. have found evidence of consumer harm, the research to date has not examined the full scope of this market or been widespread enough to capture policymaker attention.
More study is needed to determine how common these arrangements are and the cost to families and taxpayers of harmful outcomes. Although contracts-for-deed have received far more research and policymaker attention than most other alternative arrangements, lease-purchase agreements have been the subject of virtually no rigorous study despite a surge in private investment in lease-purchase start-up companies.
U.S. Census data from 2009, the last year for which data is available, shows that 4.6% of owner-occupied homes nationwide were financed with contracts for deed, but the shares of Black- and Hispanic-owned homes purchased with these arrangements are disproportionately higher (5.6% and 8.4%, respectively). Other studies similarly show that contracts-for-deed are more common in Black and Latino communities than in predominantly white neighborhoods, as well as in certain regions or states. For instance, the Federal Reserve recently found that recorded contract-for-deed use is concentrated in six Midwestern states. However, usage rates are probably vastly underestimated because of inadequate and poorly reported data.
Research also shows that contract-for-deed agreements can lead to consumer harm. For example, because buyers do not receive the deed until the loan is fully repaid, they do not have proof of ownership and their payments may not build equity. Further, the contracts often lack foreclosure or eviction protections, so buyers who miss even one payment could be forced from their homes, losing all the money and time they have invested. A study on low-income subdivisions in Texas and colonias—substandard housing developments often seen along the Texas-Mexico border—found that less than 20% of contracts-for-deed resulted in the buyer obtaining the title.
Other documented harms include the shifting of responsibility for home repairs from seller/lenders to tenant/buyers, complicated titling procedures, a lack of disclosure about the risks before agreements are signed, and inflated costs. Contracts-for-deed can also have interest rates of up to 50%, far higher than traditional mortgages, and usually do not require appraisals, which can contribute to buyers paying more than the homes are worth.
These arrangements are among the least studied models in the alternative financing market. Some companies have come under recent scrutiny for predatory practices, such as selling dilapidated homes or requiring renters to pay for repairs and upkeep. Conversely, investors, media, and other observers have highlighted some new market entrants as innovative models with the potential to increase homeownership rates. However, regardless of the specific lender, little is known about the rate of conversion to home ownership and the cost of repairs imposed on renters.
Further research is needed into lease-purchase agreements and all alternative financing options across the U.S. to quantify their variety, prevalence, and financial impacts on families, as well as the share of borrowers that successfully transition to homeownership. The Pew Charitable Trusts is undertaking a project to study these financing arrangements and provide lawmakers with research to inform evidence-based policy solutions.
Nick Bourke is the director, Tara Roche is a manager, and Rachel Siegel is an officer for The Pew Charitable Trusts’ consumer finance and home financing projects.