A land contract is an alternative to getting a mortgage or paying cash to buy a home or sell a property a bank may not want to finance.
What Is A Land Contract? A Compromise For Both The Seller And The Buyer
A land contract is a written legal agreement used to purchase various forms of real estate – including the likes of residential and commercial properties as well as industrial or farmland.
A land contract could be considered similar to a mortgage in the housing market. IN this case, however, the difference is that the buyer makes payments to the real estate owner, or seller – instead of a bank – until the purchase price is paid in full.
What Are The Rules For A Land Contract And How Do They Even Work?
A land contract is typically between the buyer and the seller.
Here’s the basic foundation for an agreement: the seller agrees to finance the property for the buyer in exchange for the buyer meeting the terms agreed upon in the land contract. In most land contracts, the seller keeps the legal title to the property until the land contract is fully paid off. While, on the other hand, the buyer is able to build up equity in the property.
The Wrap-Around Land Contract
This is a little more complicated, but, essentially, the buyer and seller agree to a seller-financed land contract, but the seller keeps paying on their existing mortgage. See how it gets a little tricky?
It still works for both parties because the seller can keep the difference between their mortgage payment and what they are paid on a monthly basis by the buyer. Unlike a straight land contract, however, the buyer gets the deed to the property immediately in a wrap-around land contract. They own the home. Again – a little tricky.
Here’s the catch, the seller’s lender has to agree to a wrap-around land contract because it means they won’t be getting the full payoff amount. They are only getting what the seller gives them.
To make up for the difference in risk, the lender also takes a junior lien position in these agreements so they can take possession of the home if the seller holding the original mortgage stops making their payments.
The Many Potential Facets Of A Land Contract
Land contracts typically have installment payments due as agreed between the buyer and seller. In many cases, there is a balloon payment to satisfy the loan terms. There are many facets of a properly executed land contract so let’s dive into what those various frameworks could look like:
Sales Price
At what number is the property being sold? That’s the sale price. Like in every loan, once you pay off this amount of principal, all of the obligations under the land contract are satisfied. If it’s a straight land contract, you’ll get the legal title at the time of payoff.
Down Payment Amount
Like in most loans, the seller will require a certain amount of guaranteed money up front. That down payment is due at closing and may be calculated as a percentage of the sale price or as an independent flat amount in the contract.
Interest Rate
The interest rate is agreed upon by the buyer and the seller. It is also determined in advance if the rate is fixed or variable. If the rate is fixed, it will always be one percentage number for the full terms of the loans. If it is variable however, the timing and conditions under which the interest rate could change should also be defined in advance – and also if there is a cap to how much it can change.
Payment Amounts
The amount of your payment should be spelled out along with how often it needs to be made, monthly or otherwise. Check to see if the contract has specific due dates and late fees. More importantly, note if there is a balloon payment due at the end of the loan term or if there is a penalty for paying the loan off early.
Responsibility Of The Parties
This is pretty basic – everyone is responsible for certain actions in the loan. In other words, the buyer agrees to make the mortgage payment and the seller will keep track of the payments. But what happens if there are any missed payments? Are they allowed? If so, what’s the timeline for paying them back, and under what conditions might the buyer become delinquent to the point that the seller takes the property back? Both parties need to be fully clear on the terms.
Title Settlement
A buyer needs language in the agreement which states they receive the legal title once all terms of the loan are satisfied.
If it’s a wrap-around mortgage, it is prudent to ensure the seller will make payments on the underlying existing mortgage. That way, the buyer can take legal action if they lose the house as a result of the seller not satisfying their end of the agreement.
Is “An Agreement To Convey” The Same Thing As A Land Contract?
All of the different terms for real estate acquisition can sound very similar, and it’s easy to get lost in all the terminology. For instance, a land contract may sound similar to a lease with an option to buy (AKA: a purchase option) or even a “rent-to-own” agreement – but they are very different. A land contract is an agreement to purchase, whereas a lease or rent option is not.
Whereas “An Agreement To Convey” is actually the same thing as a land contract. Here are the many names which also refer to a land contract.
- Land contract of sale
- Land sale contract
- Real estate sales contract
- Land installment contract
- Installment sales contract
- Agreement to convey
- Agreement for purchase and sale
- Contract for deed
- Articles of agreement for a warranty deed
- Executory contract
- Contract for sale
- Poor man’s mortgage
How Does A Buyer Protect Themselves During The Land Contract Negotiation Process?
There are many land contracts consummated every single day in the real estate world, and nearly all of them are above board. But, if you are considering a land contract, there are a number of steps you can take to better protect yourself during the negotiation process – just in case, you feel like your seller isn’t as trustworthy as you would like them to be.
Do your research. Do an online search for “land contract” and the name of the state, and another search for “land contract” and the seller’s name, to look for red flags. Do not engage with anyone if there is even a hint of a red flag to their name.
Title search. It’s important to hire a reputable title company to do a title search and issue an owner’s title insurance policy before signing a land contract. Without the search, or the proper title insurance, you’re taking an unfathomable risk that someone other than the seller may have a claim to the property. Here’s the problem, if they claim ownership of the property, and that claim supersedes the claim of the seller – your sale is essentially null. Meaning, you don’t own the property.
Escrow service. Another smart way to protect yourself as the buyer in a land contract deal is to use a third party to hold the deed to your property throughout the payment period. There are plenty of options like an escrow service, attorney or financial institution. This is important because the seller shows good faith that they do intend to transfer the deed to the buyer once the buyer makes all the agreed-upon payments. At the same time, though, the escrow service protects the seller by returning the deed if the buyer does not make the payments.
Appraisal. To make sure you’re paying a fair price for the home, order an independent, professional home appraisal. You’ll pay a few hundred dollars for the assurance that you’re not overpaying for the property. At a minimum, ask a local real estate agent if they’d be willing to give you their opinion on the home’s value.
Home inspection. DO NOT SKIP THE INSPECTION. EVER. Unless you intend to bulldoze the whole property. Your primary job is to make sure your investment is in safe and sound condition before you buy. As such, get a professional home inspection. While many land contract homes are sometimes in dreadful condition, you just need to check the actual structure to protect yourself first.
Legal recording. The seller needs to file a summary of the land contract, with the local municipality called a “memorandum of land contract”. This document should include the buyer’s and seller’s names a legal description of the property, and it should be signed by both parties in front of a notary. This is important because it formalizes the agreement and its existence becomes a matter of public record to protect the buyer’s interest in the property.
Less Legal Protection Means More Risk For You – What Are The Pros And Cons Of A Land Contract? 74
Pros
- This kind of financing can be easier to obtain because the terms can be anything that works for the buyer and seller. It doesn’t have to be heavily regulated like a traditional mortgage, and it doesn’t have the same overwhelming terms of a hard-money loan. Whatever you agree to is how it works.
- Land contracts provide a way to buy a low-cost property when a small-dollar mortgage isn’t an option. If you want a property, but can’t find the right terms for not coming up with your own money, then a land contract can make this kind of deal possible.
- There are no mortgage origination fees, and other normal closing costs are optional.
- Refinancing with a traditional mortgage after the buyer improves their credit and saves up a down payment is still an option!
Cons
- Sellers don’t often offer favorable terms in a land contract deal.
- Because of the lack of regulation, land contract interest rates may be much higher than conventional mortgage rates.
- Even if the buyer tries their best to close every loop, they could lose the home if the seller stops paying the mortgage for any reason.
- Due to the low regulation, state laws may not provide strong protections for the buyer in a land contract deal.
- Furthermore, low regulation can make it much more difficult to foreclose on a non-paying buyer, depending on state law. In fact, the process could take a year or potentially even longer.
- Refinancing is still possible, but it may not be possible under certain conditions. For instance, if the property is in poor condition, the buyer’s credit isn’t good enough, or the home value is too low.
- Part of owning a home is the collateral it affords in future deals. But with a land contract, the buyer may not be able to use the land contract as collateral for another loan and may not be able to assign or transfer their interest in the property until the contract is satisfied.
