WHAT IS A LAND CONTRACT? How It Works With Example

What is a Land Contract

Land contracts are alternatives to typical mortgage financing that are seller-financed. They are commonly utilized when purchasers cannot obtain a mortgage through a bank or another mortgage originator. They may also be unable to obtain a mortgage due to poor credit or other qualifying factors. In this post, we’ll look at the advantages and disadvantages of a down payment on land contract homes using an example, as well as what to look out for and when to utilize a refinance to convert your land contract into a standard mortgage.

Following the mortgage crisis of 2007-2010, land contract homes became increasingly popular and regarded as a viable choice. Those who have experienced a foreclosure or short sale may be able to use land contracts to purchase a home when they would not have been able to otherwise. Although they can be beneficial, land contract homes have drawbacks, so read your contract well before signing on the dotted line.

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.

Land contracts are similar to a mortgage in terms of specialty home financing. Instead of borrowing money from a lender or bank to purchase real estate, the buyer pays the real estate owner, or seller, until the purchase price is paid in full.

These types of transactions may be referred to as land contracts, installment land contracts, land sale contracts, contracts for deeds, memorandums of contracts, real estate contracts, or bonds for a title, depending on the legal or common real estate terminology in your area.

How Does A Land Contract Work?

Both parties in a transaction must sign the land contracts. The buyer will receive an impartial title or a comprehensive warranty document after the signature. This paperwork protects the buyer by allowing the buyer to accumulate equity in the asset and prohibiting the seller from incurring additional debt against the estate or selling it to others. Because these land contract homes allow the buyer to do so, the buyer can create property equity. Furthermore, the buyer is granted the right to occupy and improve the property.

A land contract, despite its name, is not always an agreement to acquire undeveloped land, though it might be. Most of the time, it’s a contract to buy the house and the land beneath and around it. It is important to remember that the individual selling the thing is also known as the vendor, and the one purchasing the item is known as the vendee.

The buyer formally becomes the property owner when the seller has fully paid. Many buyers are taken advantage of in contract talks because of this, in addition to the fact that the contract may not include everything mentioned above. This subject is expanded on in the following sections. However, first and foremost, it is critical to comprehend the various types of property contracts.

How is a Land Contract Different from a Mortgage?

Mortgages are typically designed to be sold to significant mortgage market investors such as Fannie Mae and Freddie Mac. As a result, mortgages have a widespread set of defined conditions for what happens if you miss a payment or need to make revisions to modify the loan.

Unlike standard financing, land contracts are entirely between you and the homeowner so each one will be unique. As a buyer, you must exercise extreme caution when negotiating to ensure that the terms do not place you at an unfair disadvantage.

Wrap-Around Land Contract vs. Traditional Land Contract

Let’s look at two different approaches to arranging a contract term:

#1. Traditional land contract: 

The seller retains legal ownership of the property in this sort of contract term until the contract is entirely paid off. Meanwhile, the buyer obtains equitable title, allowing them to accumulate equity in the property and maybe pay off their contract term by converting it to a standard mortgage.

#2. Wrap-around land contract: 

In a wrap-around land contract, the buyer and seller agree to a seller-financed land purchase. However, the seller continues to make payments on their existing mortgage, pocketing the difference between their mortgage payment and what the buyer pays them monthly. In contrast to a conventional contract term, the buyer in a wrap-around contract term receives the warranty deed to the property right away, implying that they own the home from the start of the contract.

One significant distinction between regular and wrap-around land contracts is that the seller’s lender must consent to a wrap-around contract term because they will not receive the entire payback amount. In these agreements, the lender also obtains a junior lien position, allowing them to repossess the land contract homes if the seller who holds the underlying mortgage stops paying a down payment.

Otherwise, both land transactions often need installment payments at agreed-upon periods. The buyer may or may not be required to make a balloon payment after the term, a lump sum that must be paid to satisfy the loan requirements.

How to Calculate Interest Rates on Land Contract Homes

Payment on a land contract may be interest-only or include the principal amount, depending on the terms of the agreement.
Fortunately, you don’t need a specialized contract terms calculator to determine how much you might pay. Simply multiply the amount funded by the interest rate and divide the result by the number of installments in a year to calculate an interest-only payment. For example, after a 10% down payment, the monthly interest payment on a $200,000 land contract property with an 8% interest rate would be $1,200.

If your payments contain principle, the interest portion of the installment payment will drop over time and vary from payment to payment.

Pros and Cons of Buying Land Contract Homes

Land contracts have a poor reputation, but they aren’t always a bad idea. But it’s critical to understand why this sale has historically been exploitative: it exposes purchasers to dangers they wouldn’t encounter in the private mortgage market.

Here are some of the primary benefits and drawbacks of a down payment for land contract homes for deed for a prospective buyer:

Pros

  • Offers an alternative to standard finance for buyers who do not qualify.
  • Buyers may be able to arrange a low down payment and monthly installment payments.
  • Buyers may find the procedure more flexible because contract terms do not have to adhere to strict norms or regulations – the buyer and seller must agree.
  • Closing expenses are reduced because loan origination fees and other fees and expenditures associated with a standard mortgage are not applicable.
  • Less time to close due to the absence of a third-party lender

Cons

  • A higher purchase price and interest rate than in a standard purchase agreement
  • If the buyer defaults, they lose all rights to the property and any payments paid.
  • Buyers may be ignorant of outstanding liens on the property, which could jeopardize their legal ownership rights.
  • Fewer safeguards than in typical deals, which means you may not have a foreclosure process and may be evicted sooner.
  • Legal ownership is withheld until the loan is fully paid off.

Why Should You Use A Land Contract?

Before engaging in a contract term, both buyers and sellers should think carefully. While they have many benefits, they also have drawbacks. Understanding both sides can help buyers and sellers decide whether the transaction is good for them.

Land Contract Example

A news update on the government of Detroit’s website emphasizes that a handbook for city residents to assist them in a contract term is being produced. The City of Detroit cooperated with UM Poverty Solutions and Enterprise Community Partners to provide materials, guidance, and proposed procedures for all stages of the contract acquisition process, thanks to a grant from the Center for Financial Empowerment.

The Contract Buyer Guide empowers buyers to take charge of the home-buying process by arming them with the information they need to make informed decisions about the property they want to buy and spot warning flags that suggest they are receiving a bad deal. This is an essential first step toward putting more Detroit people on the path to homeownership, which contributes to more housing stability, better economic mobility, and greater generational prosperity.

Land Contract Homes Alternatives

A buyer who is short on funds and/or has bad credit may be better suited to renting instead of buying while saving up for a down payment and rebuilding their credit. You can qualify for a low-down-payment conventional mortgage and possibly even get down payment help even if you have no down payment on a land contract or a down payment as low as 3%.

Another possibility is a mortgage from a portfolio lender or credit union with more lenient underwriting rules. These lenders are not required to follow the guidelines established by Fannie Mae, Freddie Mac, or the Federal Housing Administration (FHA). They may have a better solution for you that offers better terms and legal safeguards than a contract.

How to Turn A Land Contract Into A Traditional Mortgage

A typical mortgage is usually safer and more cost-effective than a contract term. As a result, it is usual for buyers to refinance with a traditional lender as quickly as possible. You should be able to refinance as soon as your credit, income, and debt-to-income (DTI) ratio meet the minimum standards if the title to the property under the contract terms is clean—that is, it has no liens or levies against it and no other ongoing difficulties.

What is another name for a land contract?

Other land contracts are contract terms, contracts for deeds, and agreements for deeds.

Does a land contract have to be recorded?

The buyer must pay property taxes according to the contract terms or memorandum. The property must be sold in the contract terms or Memorandum. Option to purchase or lease agreements is ineligible for the homestead and mortgage deductions. The land contracts or memorandum of understanding must be recorded.

Who pays property taxes on a land contract?

The buyer

However, no two agreements are alike; therefore, the parties should carefully analyze their contract to ensure that the terms and conditions are correct. A land contract requires the buyer to pay taxes. They also charge extra costs such as property taxes, mortgage interest, and insurance premiums.

What makes a land contract invalid?

The contract will be void if the subject matter is illegal. Your contract’s provisions must not violate any federal or state laws. The contract is void if the formulation or performance of the contract requires a party to violate the law.

How can I get out of a land contract?

A contract will not automatically expire if one of the parties breaches or repudiates it. To walk away from a contract, you must choose to end the contract based on the breach or repudiation. You shall notify the other party as soon as you know of their violation or repudiation.

What is an advantage of a land contract to a seller?

A land contract allows the seller to enjoy a consistent revenue flow without the headaches of managing rental property. It also provides an asset or equity stake in return for other property.

Conclusion

A land contract allows buyers to own land faster than if they applied for traditional financing. Buyers with low credit ratings or other qualifying concerns frequently use this financing. Before entering into contract terms, research the benefits and drawbacks and speak with a real estate attorney and home loan expert to ensure you understand your refinancing options when the time comes.

References

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