September 6

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Land Contracts 101

By Jeff Coffman

September 6, 2020


Estimated reading time: 6 minutes

What Is A Land Contract?

A land contract is a written legal contract, or agreement, used to purchase real estate, such as vacant land, a house, an apartment building, a commercial building or other real property. A land contract is similar to a mortgage, but rather than borrowing money from a lender or bank to buy real estate, the buyer makes payments to the real estate owner, or seller, until the purchase price is paid in full.

Depending upon the legal or common real estate terminology in your area, you may see these types of deals referred to as either land contracts, installment land contracts, contracts for deed, memorandums of contract, real estate contract or bonds for title.

When you get a mortgage, they tend to be structured so that they can be sold to major investors in the mortgage market. Because of this, mortgages have a fairly standard set of formalized terms for what happens when you miss a payment or if there are any adjustments that need to be made to modify the loan. Land contracts are completely between you and the owner of the house, so every one of them could be a little bit different. You really have to be careful when negotiating to be sure that the terms don’t put you at too much of a disadvantage.

What Does A Land Contract Cover?

A properly executed land contract has several pieces to it. Here are a few of the basic items covered:

This covers how much the property is being sold for. Once you pay off this amount of principal, your obligations under the land contract are over. If it’s a straight land contract, you’ll get the legal title at the time of payoff.

This is due at your closing and may be expressed as a percentage or a flat amount in your contract.

The interest rate is defined, as are terms around whether the rate can ever change. If it can, the timing and conditions under which the interest rate could change should also be defined.

The amount of your payment should be spelled out along with how often it needs to be made, monthly or otherwise. The contract may have specific due dates and late fees. It will also include whether there’s any balloon payment due at the end of the loan term. You should also be aware of whether the contract includes any penalty for paying off the loan early.

In addition to the basics, there should be clauses in the contract stating the responsibilities of the parties to each other. The buyer will be agreeing to make the mortgage payment. For the benefit of both parties, there should be clear language in the contract regarding what happens if the buyer falls behind on their payments. If any missed payments are allowed, 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?

From the buyer’s perspective, you’ll want language that says you get the legal title once all terms of the loan are satisfied. If it’s a wrap-around mortgage, it’s a good idea to have it written in that the seller will make payments on the underlying existing mortgage. That way, if the seller doesn’t make the payments and the buyer loses the house because of it, they have the option of legal action. You may also want a clause that requires the seller to keep careful track of your history of payments. This will make paying off your land contract with a conversion to a traditional mortgage easier later on.

Reasons for a land contract

Although most land contracts can be used for a variety of reasons, their most common use is as a form of short-term seller financing. Usually, but not always, the date on which the full amount of the purchase price is due will be years sooner than when the purchase price would be paid in full according to the amortization schedule. This results in the final payment being a large balloon payment . Since the amount of the final payment is so large, the buyer may obtain a conventional mortgage loan from a bank to make the final payment. Land contracts are sometimes used by buyers who do not qualify for conventional mortgage loans offered by a traditional lending institution, for reasons of unestablished or poor credit or an insufficient down payment.[ citation needed ] Land contracts are also used when the seller is eager to sell and the buyer is not given enough time to arrange for conventional financing.

There can be other advantages of using a land contract too. When a third-party lender, such as a financial institution, provides a loan, this third party has its own interests to protect against the other two parties involved, the seller and buyer. Establishing the correct title and value of the property to be used as collateral is important to the lender. Thus, the lender commonly requires title service including title search and title insurance by an independent title company, appraisal and termite inspection of the property to ensure it has sufficient value, a land survey to ensure there are no encroachments, and use of lawyers to ensure the closing is done correctly. These third party lender requirements add to closing costs which the lender requires the seller and/or buyer to pay. If the seller is also the lender, these costs are usually not required by the seller and may result in closing cost savings and fewer complications. It may also be the seller’s position that if the buyer requires any of these services, he could pay for the costs and make arrangements himself. For properties where only relatively undeveloped land is involved and if the seller is willing to finance, the price of the empty land may be so low that the conventional closing costs are not worthwhile and can be an impediment to a quick, simple sale. Easy financing and a simple sale transaction may be a good selling point for a seller to offer a buyer.

A land contract is a unilateral contract and cannot be assigned to another buyer without the consent of the seller providing the financing.

Benefits and Risks of a Land Contract

A land contract can be an appealing option for a potential homebuyer who might have difficulty qualifying for a mortgage loan. But there are potential risks to be wary of as well.

Land contracts were a popular way of buying a home back in the 1970s and 1980s, but fell out of favor in recent years as creative financing made it easy for almost anyone to qualify for a mortgage. However, they’ve been making something of a comeback lately as lenders have tightened credit requirements, sending some potential buyers in search of alternative financing.

A land contract is a fairly simple concept. Basically, the seller is financing the purchase instead of going through a mortgage lender. Instead of taking out a mortgage, the buyer agrees to make regular payments directly to the seller, who still retains title to the property. Once the debt is paid off, the seller transfers title to the buyer, who then owns the property free and clear.

Jeff Coffman

About the author

Jeff Coffman is a real estate investor, creative finance expert, coach and mentor to aspiring real estate entrepreneurs across the United States. Jeff provides a dynamic mix of traditional investing advice and creative real estate acquisitions strategies like "Subject-To" and Lease-Options to help investors like you build and grow your brands and businesses.

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