Pitfalls of Real Estate Contracts and How to Avoid Them

Real estate contracts provide flexibility but also come with legal and financial risks that sellers must navigate carefully.

From due-on-sale clauses to buyer defaults, understanding these pitfalls is crucial to protecting your investment and avoiding costly mistakes.

If you’re considering selling a property through a real estate contract, this guide will help you recognize the risks and apply best practices for a smooth and secure transaction.

 

Biggest Pitfall: The Due-on-Sale Clause

One of the biggest risks in real estate contracts is the due-on-sale clause—a provision found in most mortgages. This clause allows the lender to demand full repayment if they discover the property has been sold through a wraparound real estate contract or another form of owner financing.

While rare, it is more likely to happen when interest rates are low because banks may want to eliminate older, low-rate mortgages. If lenders see an opportunity to force borrowers into refinancing at higher rates, they might enforce this clause.

How to Reduce the Risk of a Due-on-Sale Clause Being Enforced

• Make consistent, on-time mortgage payments. Banks are less likely to take action if payments are made regularly.
• Have financial reserves available. Prepare for unexpected loan calls by maintaining backup funds.
• Understand lender policies. Not all lenders actively enforce the clause, but knowing their stance can help you plan accordingly.

The Risk of Buyer Default

Another significant pitfall in real estate contracts is buyer default. Even if a buyer pays an upfront down payment and makes timely payments for years, they may suddenly stop paying due to circumstances such as:

• Job loss or financial hardship
• Divorce or family issues
• Chronic illness or unexpected expenses

How Likely Is Default?

The default rate for most mortgages in the U.S. is currently under 2%, and the risk is even lower for buyers who put down at least 5% upfront. If a buyer provides 20% down, the default rate drops to nearly 1% or less.

However, it’s important to be financially prepared for the possibility of a default.

How to Protect Yourself from Buyer Default

• Have a financial cushion – If a buyer stops paying, it may take months to regain possession of the property, make necessary repairs, and resell it. Having savings or a reserve account can help cover costs.
• Stay ahead on mortgage payments – If you’re making underlying mortgage payments on a wraparound real estate contract, consider keeping 2–4 months of payments in reserve to avoid financial stress.
• Be ready for resale – If a default occurs, the property can often be resold—sometimes at a higher value than before—after making necessary updates.

Dealing with Unexpected Contract Cancellations

In one real estate contract case, a buyer who ran a restaurant purchased vacant land through owner financing. She made payments for two and a half years, but after deciding to close her business, she no longer wanted the land.

Rather than going through a lengthy legal process, both parties signed a one-page document agreeing to cancel the contract. The seller relisted the property for sale, avoiding further complications.

Not all defaults resolve this smoothly, but having a legal process in place and a financial plan can make these situations easier to handle.

Why Legal Compliance Is Essential

Beyond due-on-sale clauses and buyer defaults, another major pitfall is not structuring real estate contracts legally. Seller-financed transactions must follow specific regulations related to lending and real estate sales.

Failing to comply with these regulations can lead to:

• Legal disputes
• Fines or penalties
• Having to refund payments to the buyer

How to Ensure Compliance

• Work with a real estate attorney to ensure your contract follows legal requirements.
• Use an escrow service to track payments and execute proper legal documentation.
• Clearly define contract terms to avoid misunderstandings or disputes.

Key Terms in Real Estate Contracts

Understanding key terms in real estate contracts can help both buyers and sellers navigate potential risks and ensure transactions are legally sound. Below are important terms based on common pitfalls discussed in the transcript:

Due-on-Sale Clause

A provision in most mortgages that allows the lender to demand full repayment if the property is sold without paying off the existing loan. This clause is more likely to be enforced when interest rates increase significantly, prompting banks to eliminate older, low-rate mortgages.

Wraparound Real Estate Contract

A form of seller financing where the seller continues to make payments on an existing mortgage while the buyer pays them under a new contract. If the buyer defaults, the seller is still responsible for paying the original loan.

Default

When a buyer stops making payments on a real estate contract. Common causes include financial hardship, illness, or major life changes. If a default occurs, the seller may need to take legal action to regain and resell the property.

Down Payment

An upfront payment made by the buyer when entering a real estate contract. A larger down payment (20% or more) significantly reduces the risk of default, while a smaller down payment increases the likelihood of financial issues later.

Reserve Account

A financial cushion set aside by the seller to cover potential losses in case of default. This can help cover mortgage payments, property maintenance, or legal fees if a buyer fails to meet contract terms.

Escrow Account

A third-party account that holds funds and manages payments in a real estate contract. Using an escrow account helps track payments, notify parties of late payments, and execute legal documentation to prevent disputes.

By understanding these terms, sellers can better protect themselves against financial losses and legal risks when offering a real estate contract.

Guarantee a Smooth and Secure Real Estate Transaction

Real estate contracts can be a great tool for owner financing, but they require careful planning to avoid financial and legal pitfalls. The due-on-sale clause, buyer defaults, and legal compliance issues can create challenges, but with proper preparation, sellers can protect themselves and maximize the benefits of seller financing.

Our team at Absolute Real Estate can help you navigate real estate contract risks and ensure a smooth, legally compliant transaction. Contact us today to learn more about how we can support your real estate financing goals.